[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2012 Edition]
[From the U.S. Government Printing Office]



[[Page i]]

          

          Title 26

Internal Revenue


________________________

Parts 50 to 299

                         Revised as of April 1, 2012

          Containing a codification of documents of general 
          applicability and future effect

          As of April 1, 2012
                    Published by the Office of the Federal Register 
                    National Archives and Records Administration as a 
                    Special Edition of the Federal Register

[[Page ii]]

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                            Table of Contents



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

  Title 26:
          Chapter I--Internal Revenue Service, Department of 
          the Treasury (Continued)                                   3
  Finding Aids:
      Table of CFR Titles and Chapters........................     583
      Alphabetical List of Agencies Appearing in the CFR......     603
      Table of OMB Control Numbers............................     613
      List of CFR Sections Affected...........................     631

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

                     Cite this Code: CFR
                     To cite the regulations in 
                       this volume use title, 
                       part and section number. 
                       Thus, 26 CFR 50.1 refers 
                       to title 26, part 50, 
                       section 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

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

EFFECTIVE AND EXPIRATION DATES

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Register since the last revision of that volume of the Code. Source 
citations for the regulations are referred to by volume number and page 
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inserted following the text.

OMB CONTROL NUMBERS

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

[[Page vi]]

Many agencies have begun publishing numerous OMB control numbers as 
amendments to existing regulations in the CFR. These OMB numbers are 
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OBSOLETE PROVISIONS

    Provisions that become obsolete before the revision date stated on 
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of provisions in effect on a given date in the past by using the 
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``[RESERVED]'' TERMINOLOGY

    The term ``[Reserved]'' is used as a place holder within the Code of 
Federal Regulations. An agency may add regulatory information at a 
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INCORPORATION BY REFERENCE

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This material, like any other properly issued regulation, has the force 
of law.
    What is a proper incorporation by reference? The Director of the 
Federal Register will approve an incorporation by reference only when 
the requirements of 1 CFR part 51 are met. Some of the elements on which 
approval is based are:
    (a) The incorporation will substantially reduce the volume of 
material published in the Federal Register.
    (b) The matter incorporated is in fact available to the extent 
necessary to afford fairness and uniformity in the administrative 
process.
    (c) The incorporating document is drafted and submitted for 
publication in accordance with 1 CFR part 51.
    What if the material incorporated by reference cannot be found? If 
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    An index to the text of ``Title 3--The President'' is carried within 
that volume.

[[Page vii]]

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This index is based on a consolidation of the ``Contents'' entries in 
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the revision dates of the 50 CFR titles.

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INQUIRIES

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or write to the Director, Office of the Federal Register, National 
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    Michael L. White,
    Acting Director,
    Office of the Federal Register.
    April 1, 2012.







[[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, 
2012. 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 of part 1. 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 
Michael L. White, assisted by Ann Worley.

[[Page 1]]



                       TITLE 26--INTERNAL REVENUE




                  (This book contains parts 50 to 299)

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

chapter i--Internal Revenue Service, Department of the 
  Treasury (Continued)......................................          50

[[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, Mar. 31, 1980.

          SUBCHAPTER D--MISCELLANEOUS EXCISE TAXES (CONTINUED)
Part                                                                Page
50              Regulations relating to the tax imposed with 
                    respect to certain hydraulic mining.....           5
51              Branded prescription drug fee...............           7
52              Environmental taxes.........................          16
53              Foundation and similar excise taxes.........          50
54              Pension excise taxes........................         267
55              Excise tax on real estate investment trusts 
                    and regulated investment companies......         508
56              Public charity excise taxes.................         514
141             Temporary excise tax regulations under the 
                    Employee Retirement Income Security Act 
                    of 1974.................................         554
143             Temporary excise tax regulations under the 
                    Tax Reform Act of 1969..................         554
145             Temporary excise tax regulations under the 
                    Highway Revenue Act of 1982 (Pub. L. 97-
                    424)....................................         556
148             Certain excise tax matters under the Excise 
                    Tax Technical Changes Act of 1958.......         566
151-155

[Reserved]

156             Excise tax on greenmail.....................         568
157             Excise tax on structured settlement 
                    factoring transactions..................         574
158-169

[Reserved]

                         SUBCHAPTER E [RESERVED]
170-299

[Reserved]


Supplementary Publications: Internal Revenue Service Looseleaf 
  Regulations System.

  Additional supplementary publications are issued covering Alcohol, 
Tobacco and Firearms Regulations, and Regulations Under Tax Conventions.

[[Page 5]]



           SUBCHAPTER D_MISCELLANEOUS EXCISE TAXES (CONTINUED)





PART 50_REGULATIONS RELATING TO THE TAX IMPOSED WITH RESPECT TO CERTAIN
HYDRAULIC MINING--Table of Contents



Sec.
50.1 Introduction.
50.2 Scope of regulations.
50.3 General definitions and use of terms.
50.4 Rates of tax.
50.5 Liability for the tax.
50.6 Ascertainment of quantity mined.
50.7 Returns.
50.8 Due date and place for filing returns and paying tax.

    Authority: Sec. 23, 27, Stat. 510, as amended; 33 U.S.C. 683.

    Source: T.D. 6419, 24 FR 8546, Oct. 22, 1959, unless otherwise 
noted.



Sec. 50.1  Introduction.

    The Act entitled ``An Act to create the California Debris Commission 
and regulate hydraulic mining in the State of California'', approved 
March 1, 1893, as amended, 27 Stat. 507; 34 Stat. 1001; 48 Stat. 1118; 
52 Stat. 1040; 61 Stat. 501; 33 U.S.C. 661-687, provides in part as 
follows:

    That a commission is hereby created, to be known as the California 
Debris Commission, consisting of three members. * * *
    Sec. 3. That the jurisdiction of said commission, insofar as the 
same affects mining carried on by the hydraulic process, shall extend to 
all such mining in the territory drained by the Sacramento and San 
Joaquin river systems in the State of California. * * *
    Sec. 8. That for the purposes of this act ``hydraulic mining'' and 
``mining by the hydraulic process,'' are hereby declared to have the 
meaning and application given to said terms in said State.
    Sec. 9. That the individual proprietor or proprietors, or in the 
case of a corporation its manager or agent appointed for that purpose, 
owning mining ground in the territory in the State of California 
mentioned in section three hereof, which it is desired to work by the 
hydraulic process, must file with said commission a verified petition, 
setting forth such facts as will comply with law and the rules 
prescribed by said commission.

                                * * * * *

    Sec. 13. That in case a majority of the members of said Commission, 
within thirty days after the time so fixed, concur in the decision in 
favor of the petitioner or petitioners, the said Commission shall 
thereupon make an order directing the methods and specifying in detail 
the manner in which operations shall proceed in such mine or mines; * * 
*
    Sec. 23. Upon the construction by the said commission of dams or 
other works for the detention of debris from hydraulic mines and the 
issuing of the order provided for by this Act to any individual, 
company, or corporation to work any mine or mines by hydraulic process, 
the individual, company, or corporation operating thereunder working any 
mine or mines by hydraulic process, the debris from which flows into or 
is in whole or in part restrained by such dams or other works erected by 
said commission, shall pay for each cubic yard mined from the natural 
bank a tax equal to the total capital cost of the dam, reservoir, and 
rights of way divided by the total capacity of the reservoir for the 
restraint of debris, as determined in each case by the California Debris 
Commission, which tax shall be paid annually on a date fixed by said 
commission and in accordance with regulations to be adopted by the 
Secretary of the Treasury, and the Treasurer of the United States is 
hereby authorized to receive the same. * * * The Secretary of the Army 
is authorized to enter into contracts to supply storage for water and 
use of outlet facilities from debris storage reservoirs, for domestic 
and irrigation purposes and power development upon such conditions of 
delivery, use, and payment as he may approve: Provided, That the moneys 
received from such contracts shall be deposited to the credit of the 
reservoir project from which the water is supplied, and the total 
capital cost of said reservoir, which is to be repaid by tax on mining 
operations as herein provided, shall be reduced in the amount so 
received.



Sec. 50.2  Scope of regulations.

    (a) In general. The regulations in this part relate to the tax 
imposed with respect to hydraulic mining, the debris from which flows 
into or is in whole or in part restrained by dams or other works erected 
for the detention of debris by the California Debris Commission in the 
area drained by the Sacramento and San Joaquin river systems in the 
State of California. The regulations have application to taxable years 
beginning after August 31, 1959.

[[Page 6]]

For definition of the term taxable year, see Sec. 50.3(g).
    (b) Extent to which the regulations in this part supersede prior 
regulations. The regulations in this part, with respect to the subject 
matter within the scope thereof, supersede Treasury Decision 4952 (26 
CFR (1939) part 317).



Sec. 50.3  General definitions and use of terms.

    As used in the regulations in this part:
    (a) The term Act means ``An Act to create the California Debris 
Commission and regulate hydraulic mining in the State of California'' 
approved March 1, 1893, as amended, 27 Stat. 507; 34 Stat. 1001; 48 
Stat. 1118; 52 Stat. 1040; 61 Stat. 501; 33 U.S.C. 661-687.
    (b) The term person means an individual, a trust, estate, 
partnership, company, or corporation.
    (c) The term Secretary means the Secretary of the Treasury.
    (d) The term Commissioner means the Commissioner of Internal 
Revenue.
    (e) The term district director means the district director of 
internal revenue.
    (f) The terms hydraulic mining and mining by the hydraulic process 
shall have the meaning and application given said terms in the State of 
California.
    (g) The term taxable year means the twelve-month period ending on 
August 31 of each year for which the tax imposed by the Act is payable.



Sec. 50.4  Rates of tax.

    (a) Determination of rate. Under the Act the California Debris 
Commission will determine and prescribe with respect to each debris dam 
or other works the rate of tax payable in the area served by the 
particular debris dam or works. The Secretary of the Army will notify 
the Secretary of the Treasury of the rate of tax fixed with respect to 
each debris dam or works as such rate becomes known.
    (b) Measure of tax. The tax is payable annually on the basis of the 
number of cubic yards mined from the natural bank by the hydraulic 
process during the taxable year.



Sec. 50.5  Liability for the tax.

    Liability for tax attaches to any person engaged at any time during 
the taxable year in hydraulic mining in the area identified in paragraph 
(a) of Sec. 50.2, if the debris from such mining operations is in whole 
or in part restrained by any of the debris dams or works constructed by 
the California Debris Commission.



Sec. 50.6  Ascertainment of quantity mined.

    Each person engaged in hydraulic mining operations within the scope 
of the tax shall make or cause to be made appropriate surveys of the 
premises on which such hydraulic mining operations are conducted for the 
purpose of determining the cubic yardage mined from the natural bank. 
Such surveys shall be made at the beginning and end of hydraulic mining 
operations in each taxable year by a licensed engineer or other 
qualified agency having prior approval of the California Debris 
Commission, and shall conform to requirements prescribed by the 
California Debris Commission.



Sec. 50.7  Returns.

    (a) Form of return. Every person liable for tax for any taxable year 
shall prepare for such year a return on Form 1 (California Debris) in 
accordance with the instructions thereon and in accordance with the 
regulations in this part.
    (b) Content of return. The return shall show:
    (1) The identity of the particular dam or other works restraining 
debris from the mine;
    (2) The name and location of the mine;
    (3) The name and address of the person to whom the California Debris 
Commission has issued a license to operate the mine;
    (4) The number and date of the license;
    (5) The name and address of the owner of the mine;
    (6) The dates on which hydraulic mining operations began and ended 
during the taxable year for which the return is made;
    (7) The number of cubic yards mined by the hydraulic process at the 
mine during the taxable year;

[[Page 7]]

    (8) The rate of tax per cubic yard determined by the California 
Debris Commission applicable to the particular mine; and
    (9) The amount of tax due and payable (cubic yards mined multiplied 
by the rate of tax per cubic yard).
    (c) Supporting statement. With each return there must be submitted a 
supporting statement of the person who made the surveys at the mine for 
the mining season covered by the return (see Sec. 50.6), stating that 
such surveys were made in accordance with requirements prescribed by the 
California Debris Commission.
    (d) Verification of return and supporting statement. The return and 
the supporting statement shall be verified by written declarations that 
they are made under the penalties of perjury.



Sec. 50.8  Due date and place for filing returns and paying tax.

    The return for a taxable year shall be filed with, and the tax shall 
be paid to, the district director at San Francisco, California, on or 
before September 30 of the calendar year in which the taxable year ends. 
The tax is due and payable on such date without assessment by, or notice 
from, the district director.



PART 51_BRANDED PRESCRIPTION DRUG FEE--Table of Contents



Sec.
51.1T Overview (temporary).
51.2T Explanations of terms (temporary).
51.3T Information requested from covered entities (temporary).
51.4T Information provided by the agencies (temporary).
51.5T Fee calculation (temporary).
51.6T Notice of preliminary fee calculation (temporary).
51.7T Dispute resolution process (temporary).
51.8T Notification and payment of fee (temporary).
51.9T Tax treatment of fee (temporary).
51.10T Refund claims (temporary).
51.11T Effective/applicability date (temporary).
51.12T Expiration date (temporary).
51.6302-1T Method of paying the branded prescription drug fee 
          (temporary).

    Authority: 26 U.S.C. 7805; sec. 9008, Public Law 111-347 (124 Stat. 
119).
    Section 51.8 also issued under 26 U.S.C. 6302(a).
    Section 51.6302-1 also issued under 26 U.S.C. 6302(a).

    Source: T.D. 9544, 76 FR 51249, Aug. 18, 2011, unless otherwise 
noted.



Sec. 51.1T  Overview (temporary).

    (a) The regulations in this part 51 are designated ``Branded 
Prescription Drug Fee Regulations.''
    (b) The regulations in this part 51 provide guidance on the annual 
fee imposed on covered entities engaged in the business of manufacturing 
or importing branded prescription drugs by section 9008 of the Patient 
Protection and Affordable Care Act (ACA), Public Law 111-148 (124 Stat. 
119 (2010)), as amended by section 1404 of the Health Care and Education 
Reconciliation Act of 2010 (HCERA), Public Law 111-152 (124 Stat. 1029 
(2010)). All references in these regulations to section 9008 are 
references to section 9008 of the ACA, as amended by section 1404 of 
HCERA. Unless otherwise indicated, all other section references are to 
sections in the Internal Revenue Code. All references to ``fee'' in 
these regulations are references to the fee imposed by section 9008.
    (c) Section 9008(b)(4) sets an applicable fee amount for each year, 
beginning with 2011, that will be apportioned among covered entities 
with aggregate branded prescription drug sales of over $5 million to 
government programs or pursuant to coverage under such programs. 
Generally, each covered entity is liable for a fee in each fee year that 
is based on its sales of branded prescription drugs in the sales year 
that corresponds to the fee year in an amount determined by the Internal 
Revenue Service (IRS) under the rules of this part.



Sec. 51.2T  Explanation of terms (temporary).

    (a) In general. This section explains the terms used in this part 
for purposes of the fee imposed by section 9008 on branded prescription 
drugs.
    (b) Agencies. The term agencies means--
    (1) The Centers for Medicare and Medicaid Services of the Department 
of Health and Human Services (CMS);
    (2) The Department of Veterans Affairs (VA); and

[[Page 8]]

    (3) The Department of Defense (DOD).
    (c) Branded prescription drug--(1) In general. The term branded 
prescription drug means--
    (i) Any prescription drug the application for which was submitted 
under section 505(b) of the Federal Food, Drug, and Cosmetic Act (21 
U.S.C. 355(b)); or
    (ii) Any biological product the license for which was submitted 
under section 351(a) of the Public Health Service Act (42 U.S.C. 
262(a)).
    (2) Prescription drug. The term prescription drug means any drug 
that is subject to section 503(b) of the Federal Food, Drug, and 
Cosmetic Act (21 U.S.C. 353(b)).
    (d) Branded prescription drug sales. The term branded prescription 
drug sales means sales of branded prescription drugs to any government 
program or pursuant to coverage under any such government program. 
However, the term does not include sales of orphan drugs.
    (e) Covered entity--(1) In general. The term covered entity means 
any manufacturer or importer with gross receipts from branded 
prescription drug sales including--
    (i) A single-person covered entity; or
    (ii) A controlled group.
    (2) Single-person covered entity. The term single-person covered 
entity means a covered entity that is not affiliated with any other 
covered entity.
    (3) Controlled group. The term controlled group means a group of at 
least two covered entities that are treated as a single employer under 
section 52(a), 52(b), 414(m), or 414(o).
    (4) Special rules for controlled groups. For purposes of paragraph 
(e)(3) of this section (related to controlled groups)--
    (i) A foreign entity subject to tax under section 881 is included 
within a group under section 52(a) or 52(b); and
    (ii) A covered entity is treated as being a member of a controlled 
group if it is a member of the group on the end of the day on December 
31st of the sales year.
    (f) Designated entity--(1) In general. The term designated entity 
means the person that acts for a controlled group regarding the fee by--
    (i) Filing Form 8947, ``Report of Branded Prescription Drug 
Information'';
    (ii) Receiving IRS communications about the fee for the group;
    (iii) Filing an error report for the group, if applicable, as 
described in Sec. 51.7T; and
    (iv) Paying the fee to the IRS.
    (2) Selection of designated entity--(i) Choice of controlled group. 
Unless the controlled group is an affiliated group that filed a 
consolidated return for Federal income tax purposes, the controlled 
group may select a person as the designated entity by filing Form 8947 
in accordance with the form instructions. Among other requirements, the 
designated entity must state that all the manufacturers or importers of 
branded prescription drugs that are members of the group have consented 
to the selection of the designated entity.
    (ii) Requirement for affiliated groups; common parent. If the 
controlled group, without regard to foreign corporations included under 
section 9008(d)(2)(B), is also an affiliated group that filed a 
consolidated return for Federal income tax purposes, the designated 
entity is the common parent of the affiliated group as identified on the 
tax return filed for the sales year. The covered entities in an 
affiliated group must name the common parent as the designated entity on 
Form 8947.
    (iii) IRS selection of a designated entity. If a controlled group 
does not select a designated entity, the IRS will select a member of the 
controlled group as the designated entity for the controlled group.
    (g) Fee year. The term fee year means the calendar year in which the 
fee for a particular sales year must be paid to the government.
    (h) Government programs. The term government programs (collectively 
``Programs''), means--
    (1) The Medicare Part B program;
    (2) The Medicare Part D program;
    (3) The Medicaid program;
    (4) Any program under which branded prescription drugs are procured 
by the Department of Veterans Affairs;
    (5) Any program under which branded prescription drugs are procured 
by the Department of Defense; and

[[Page 9]]

    (6) The TRICARE retail pharmacy program.
    (i) Manufacturer or importer. The term manufacturer or importer 
means the person identified in the Labeler Code of the National Drug 
Code (NDC) for a branded prescription drug.
    (j) NDC. The term NDC means the National Drug Code. The NDC is an 
identifier assigned by the Food and Drug Administration (FDA) to a 
branded prescription drug, as well as other drugs. The Labeler Code is 
the first five numeric characters of the NDC or the first six numeric 
characters when the available five-character code combinations are 
exhausted.
    (k) Orphan drugs--(1) In general. Except as provided in paragraph 
(k)(2) of this section, the term orphan drug means any branded 
prescription drug for which any person claimed a section 45C credit and 
that credit was allowed for any taxable year.
    (2) Exclusions. The term orphan drug does not include--
    (i) Any drug for which there has been a final assessment or court 
order disallowing the full section 45C credit taken for the drug; or
    (ii) Any drug for any sales year after the calendar year in which 
the FDA approved the drug for marketing for any indication other than 
the treatment of a rare disease or condition for which a section 45C 
credit was allowed, regardless of whether a section 45C credit was 
allowed for the drug either before, in the same year as, or after this 
FDA designation.
    (3) FDA marketing approval for treatment of another rare disease or 
condition. If a drug has prior FDA marketing approval for the treatment 
of a rare disease or condition for which a section 45C credit was 
allowed, and the FDA subsequently gives the drug marketing approval for 
the treatment of another rare disease or condition for which another 
section 45C credit was also allowed, the drug retains its status as an 
orphan drug provided the FDA has never approved the drug for marketing 
for any indication other than the treatment of a rare disease or 
condition for which a section 45C credit was allowed.
    (4) Examples. The following examples illustrate the rules of this 
paragraph (k):

    Example 1: Allowance of section 45C credit and later FDA marketing 
approval of drug for an indication other than the treatment of a rare 
disease or condition. (i) Facts. Drug A is a branded prescription drug 
that was not on the market before 2008. In 2008, a covered entity 
claimed a section 45C credit for its qualified clinical testing expenses 
related to Drug A. There was no final IRS assessment or court order that 
disallowed the full credit for Drug A. In 2009, the FDA approved Drug A 
for marketing for an indication other than the treatment of the rare 
disease or condition for which the section 45C credit was allowed and 
this indication was not for another rare disease or condition for which 
a section 45C was allowed.
    (ii) Analysis. In 2008 and 2009, Drug A is an orphan drug because: 
first, it was a branded prescription drug for which a person claimed a 
section 45C credit and for which that credit was allowed for a taxable 
year; second, there was not a final assessment or court order 
disallowing the full credit taken for the drug; and third, before 2009, 
the FDA did not approve the drug for marketing for any indication other 
than the treatment of a rare disease or condition for which a section 
45C credit was allowed. However, Drug A is not an orphan drug for the 
2010 sales year or later sales years because in 2009 the FDA approved 
Drug A for marketing for an indication other than the treatment of the 
rare disease or condition for which the section 45C credit was allowed 
and this indication was not for treatment of another rare disease or 
condition for which a section 45C credit was allowed.

    Example 2: FDA marketing approval of drug for an indication other 
than the treatment of a rare disease or condition and later allowance of 
section 45C credit. (i) Facts. Drug B is a branded prescription drug 
that was not on the market before 2008. In 2008, FDA approved Drug B for 
marketing for an indication other than the treatment of a rare disease 
or condition for which a section 45C credit was allowed. In 2009, a 
covered entity claimed a section 45C credit for its qualified clinical 
testing expenses related to Drug B. There was no final IRS assessment or 
court order that disallowed the full credit for Drug B.
    (ii) Analysis. In 2008, Drug B is not an orphan drug because no 
section 45C credit was allowed. In 2009, although the covered entity was 
allowed a section 45C credit for its qualified clinical testing expenses 
related to Drug B and there was no final IRS assessment or court order 
that disallowed the full credit, Drug B still is not an orphan drug 
because the FDA had approved the drug in 2008 for marketing for an 
indication other than the treatment of a rare disease or condition for 
which a section 45C credit was allowed in 2009. Thus, Drug B is not an 
orphan drug for the 2009 sales year or later sales years.


[[Page 10]]


    Example 3: Allowance of section 45C credit and subsequent allowance 
of section 45C credit with no intervening FDA marketing approval of drug 
for an indication other than the treatment of a rare disease or 
condition for which a section 45C credit was allowed. (i) Facts. Drug C 
is a branded prescription drug that was not on the market before 2007. 
In 2007, a covered entity claimed a section 45C credit for its qualified 
clinical testing expenses related to Drug C. In 2009, a covered entity 
claimed an additional section 45C credit for its qualified clinical 
testing expenses related to Drug C for marketing for the treatment of a 
rare disease or condition different than the one for which the section 
45C credit was claimed in 2007. There was no final IRS assessment or 
court order that disallowed the full credit for Drug C in 2007 or 2009. 
The FDA has not approved Drug C for an indication other than the 
treatment of a rare disease or condition for which a section 45C was 
allowed.
    (ii) Analysis. In 2007 and 2008, Drug C is an orphan drug because: 
first, it was a branded prescription drug for which a person claimed a 
section 45C credit and for which that credit was allowed for a taxable 
year; second, there was not a final assessment or court order 
disallowing the full credit taken for the drug; and third, FDA had not 
approved the drug for marketing for any indication other than the 
treatment of a rare disease or condition for which a section 45C credit 
was allowed. In 2009, Drug C retains its orphan drug status because 
another section 45C credit was allowed and the FDA did not approve Drug 
C for marketing for any indication other than the treatment of another 
rare disease or condition for which a section 45C credit was allowed. 
Thus, Drug C is an orphan drug for the 2010 sales year.

    (l) Sales taken into account. The term sales taken into account 
means branded prescription drug sales after application of the 
percentage adjustment table in section 9008(b)(2) (relating to annual 
sales less than $400,000,001). See Sec. 51.5T(a)(3).
    (m) Sales year. The term sales year means the second calendar year 
preceding the fee year. Thus, for example, for the fee year of 2011, the 
sales year is 2009.

[T.D. 9544, 76 FR 51249, Aug. 18, 2011; 76 FR 59897, Sept. 28, 2011]



Sec. 51.3T  Information requested from covered entities (temporary).

    (a) In general. Annually, each covered entity may submit a completed 
Form 8947, ``Report of Branded Prescription Drug Information,'' in 
accordance with the instructions for the form. Generally, the form 
solicits information from covered entities on NDCs, orphan drugs, 
designated entities, rebates, and other information specified by the 
form or its instructions.
    (b) Due date. Form 8947 must be filed by the date prescribed in 
guidance in the Internal Revenue Bulletin.



Sec. 51.4T  Information provided by the agencies (temporary).

    (a) In general. For each sales year, the IRS will compile a list of 
branded prescription drugs by NDC using the data submitted on Forms 8947 
and in error reports submitted as part of the dispute resolution process 
(described in Sec. 51.7T) and, after applying appropriate due 
diligence, will provide this list to the Agencies. The Agencies will 
provide data to the IRS on branded prescription drug sales during the 
sales year by Program and NDC. The Agencies will provide data for use in 
preparing the preliminary fee calculation (described in Sec. Sec. 51.5T 
and 51.6T) and may revise or supplement that data following review of 
error reports submitted as part of the dispute resolution process. The 
calculation methodology for calculating the sales amounts for each 
Program, including any reasonable estimation techniques and assumptions 
that the Agencies expect to use, is described in this section.
    (b) Medicare Part D. CMS will aggregate the ingredient cost reported 
in the ``Ingredient Cost Paid'' field and the units reported in the 
``Quantity Dispensed'' field of the Prescription Drug Event (PDE) 
records at the NDC level for each sales year. Only PDE data that Part D 
sponsors have submitted by the PDE submission deadline (within 6 months 
after the end of the sales year) and have been approved for inclusion in 
the Part D payment reconciliation will be included.
    (c) Medicare Part B--(1) In general. CMS will determine branded 
prescription drug sales under Medicare Part B using the following two 
data sources:
    (i) CMS will use data reported by manufacturers pursuant to section 
1847A(c) of the Social Security Act to calculate the annual weighted 
average sales price (ASP) for each Healthcare Common Procedure Coding 
System (HCPCS) code for the sales year.

[[Page 11]]

    (ii) CMS will use the Medicare Part B National Summary Data File 
located at http://www.cms.gov/NonIdentifiableDataFiles/03--
PartBNationalSummaryDataFile.asp to obtain the number of allowed billing 
units per HCPCS code for claims incurred during the sales year.
    (2) Calculation. Using the data described in paragraph (c)(1) of 
this section, CMS will determine branded prescription drugs sales under 
Medicare Part B as described in paragraphs (c)(3), (4), and (5) of this 
section.
    (3) HCPCS code; single entity. For each HCPCS code consisting solely 
and exclusively of branded prescription drugs (as identified by their 
respective NDCs) manufactured by a single entity, CMS will multiply the 
annual weighted ASP by the total number of allowed billing units paid 
during the sales year to determine the total sales for all NDCs 
associated with the HCPCS code attributed to Medicare Part B.
    (4) HCPCS code; multiple manufacturers and/or multiple drugs--(i) 
Step one. For each HCPCS code consisting of a mixture of branded 
prescription drugs made by different manufacturers and/or a mixture of 
branded prescription and generic drugs, CMS will determine--
    (A) The annual weighted ASP for the HCPCS code;
    (B) The total number of allowed billing units paid by Medicare Part 
B for each HCPCS code during the sales year;
    (C) The names of the entities engaged in manufacturing each NDC 
assigned to the HCPCS code; and
    (D) Those entities (if any) identified in paragraph (c)(4)(C) of 
this section that are manufacturing branded prescription drugs assigned 
to the HCPCS code.
    (ii) Step two. Using the information from paragraph (c)(4)(i) of 
this section, CMS will then do the following:
    (A) Calculate the proportion of sales, expressed as a percentage, 
attributed to each NDC assigned to the HCPCS code by determining the 
percentage of total sales reported to CMS by each manufacturer of NDC(s) 
that are assigned to the HCPCS code. For example, if HCPCS code JXXXX 
contains three drugs with a total of $310,000 sales reported by 
manufacturers to CMS for the sales year, and $100,000 was reported for 
Drug A, $200,000 was reported for Drug B, and $10,000 was reported for 
Drug C, the proportion of sales attributed to each NDC will be 32.26 
percent for Drug A, 64.52 percent for Drug B, and 3.22 percent for Drug 
C; and
    (B) For each NDC, multiply the product of the annual weighted ASP 
and the total allowed billing units paid by Medicare Part B for the 
HCPCS code by the proportion of sales calculated in paragraph 
(c)(4)(ii)(A) of this section to determine the sales reportable to the 
IRS (that is, percentage x (annual weighted ASP x allowed units) = total 
sales reported to IRS for the NDC). The sales for each manufacturer's 
NDCs assigned to a HCPCS code are summed and the total sales for each 
manufacturer's NDCs in a HCPCS code will be reported to the IRS.
    (5) HCPCS code; unable to establish a reliable proportion of sales. 
If CMS is unable to establish a reliable proportion of sales 
attributable to each NDC assigned to the HCPCS code using the method 
described in paragraph (c)(4)(ii)(A) of this section, CMS will use 
Medicare Part D utilization percentages in lieu of the proportion of 
sales determined under paragraph (c)(4)(ii)(A) of this section to 
perform the calculation described in paragraph (c)(4)(ii)(B) of this 
section.
    (d) Medicaid. (1) CMS will determine the branded prescription drug 
sales for Medicaid as the per-unit Average Manufacturer Price (AMP) less 
the Unit Rebate Amounts (URA) that CMS calculates based on manufacturer-
reported pricing data multiplied by the number of units reported billed 
by states to manufacturers. This data will be based on the data reported 
to CMS during the sales year by covered entities and the states for 
drugs paid for by the states in the Medicaid drug rebate program during 
the sales year.
    (2) For any covered entity identified in the first five (or six) 
digits of an NDC during any of the four quarters of a sales year, CMS 
will use the following methodology to derive the sales figures that 
account for third-party payers, such as Medicare Part B:

[[Page 12]]

    (i) Report total dollars per NDC for AMP-URA multiplied by the units 
reported by a state or states.
    (ii) Determine the percentage of the total amount reimbursed that is 
the Medicaid amount of that reimbursement. For example, if the total 
amount reimbursed is $100,000, and the Medicaid amount reimbursed is 
$20,000, then the percentage is 20 percent.
    (iii) Multiply the percentage of the Medicaid amount of that 
reimbursement (in the example in paragraph (d)(2)(ii) of this section, 
20 percent) by the dollar figure derived from paragraph (d)(2)(i) of 
this section (AMP minus URA multiplied by units) to get the new adjusted 
sales dollar totals.
    (e) Department of Veterans Affairs. VA will provide, by NDC, the 
total amount paid (net of refunds and rebates, when they are associated 
with a specific NDC) for each branded prescription drug procured by the 
VA for its beneficiaries during the sales year. For this purpose, a drug 
is procured on the invoice (billing) date. The basis of this information 
will be national procurement data reported during the sales year by VA's 
Pharmaceutical Prime Vendor to the VA Pharmacy Benefits Management 
Service and National Acquisition Center.
    (f) Department of Defense. The DOD will provide, by Labeler Code, 
the manufacturer's name, the NDC, brand name, and the amount paid (net 
of rebates and or refunds) for each branded prescription drug procured 
by DOD (for DOD programs other than the TRICARE retail pharmacy program) 
during the sales year. For DOD programs other than the TRICARE retail 
pharmacy program, a drug is procured based upon the date it was ordered. 
DOD will provide, by Labeler Code, the manufacturer's name, the NDC, 
brand name, and the amount paid (net of rebates or refunds) for each 
branded prescription drug procured by DOD through the TRICARE Retail 
Pharmacy Program during the sales year. For the TRICARE retail pharmacy 
program, a drug is procured based upon the date it was dispensed. The 
amount paid is based on the submitted ingredient cost paid, aggregated 
by NDC, for eligible TRICARE retail pharmacy claims submitted during the 
program year, minus any refunds or rebates for the corresponding claims.



Sec. 51.5T  Fee calculation (temporary).

    (a) Fee components--(1) In general. For every fee year, the IRS will 
calculate a covered entity's total fee as described in this section. For 
each fee year after 2011, the IRS will determine a covered entity's 
total fee by applying, if applicable, the adjustment amount described in 
paragraph (e) of this section to the entity's allocated fee described in 
paragraph (d) of this section.
    (2) Calculation of branded prescription drug sales. Each covered 
entity's allocated fee for any fee year is equal to an amount that bears 
the same ratio to the applicable amount as the covered entity's branded 
prescription drug sales taken into account during the sales year bears 
to the aggregate branded prescription drug sales of all covered entities 
taken into account during the sales year.
    (3) Applicable amount. The applicable amounts for fee years are--

------------------------------------------------------------------------
                      Fee year                         Applicable amount
------------------------------------------------------------------------
2011................................................      $2,500,000,000
2012................................................       2,800,000,000
2013................................................       2,800,000,000
2014................................................       3,000,000,000
2015................................................       3,000,000,000
2016................................................       3,000,000,000
2017................................................       4,000,000,000
2018................................................       4,100,000,000
2019 and thereafter.................................       2,800,000,000
------------------------------------------------------------------------

    (3) Sales taken into account. A covered entity's branded 
prescription drug sales taken into account during any calendar year are 
as follows:

------------------------------------------------------------------------
                                                         Percentage of
                                                            branded
  Covered entity's branded prescription drug sales     prescription drug
         during the calendar year that are:            sales taken into
                                                          account is
------------------------------------------------------------------------
Not more than $5,000,000............................                   0
More than $5,000,000 but not more than $125,000,000.                  10
More than $125,000,000 but not more than                              40
 $225,000,000.......................................
More than $225,000,000 but not more than                              75
 $400,000,000.......................................
More than $400,000,000..............................                 100
------------------------------------------------------------------------

    (b) Determination of branded prescription drug sales. The IRS will 
compile each covered entity's branded prescription drug sales for each 
Program by NDC. Each NDC will be attributed to the covered entity that 
owns the NDC

[[Page 13]]

as of the end of the day on December 31st of the sales year. For a 
covered entity that is a controlled group, this includes all NDCs that a 
member of the covered entity owns as of the end of the day on December 
31st of the sales year. For this purpose, the IRS may revise the list of 
NDCs as a result of information received in the dispute resolution 
process, and the data the IRS uses to produce the final fee calculation 
will include any revisions provided by the Agencies at the completion of 
the dispute resolution process. Each covered entity's branded 
prescription drug sales will be reduced by its Medicare Part D rebates 
and Medicaid state supplemental rebate amounts in the following manner. 
If CMS has the rebate information for these Programs for a sales year, 
CMS will report to the IRS branded prescription drug sales net of 
rebates. If CMS does not have the rebate information for these programs 
for a sales year, the IRS will reduce the branded prescription drug 
sales reported for these Programs by rebates reported by the covered 
entities on Forms 8947.
    (c) Determination of sales taken into account. (1) For each sales 
year and for each covered entity, the IRS will calculate sales taken 
into account. The resulting number is the numerator of the ratio 
described in paragraph (d)(1) of this section.
    (2) For each sales year, the IRS will calculate the aggregate 
branded prescription drug sales taken into account for all covered 
entities. The resulting number is the denominator of the ratio described 
in paragraph (d)(2) of this section.
    (d) Allocated fee calculation. For each covered entity for each fee 
year, the IRS will calculate the entity's allocated fee by multiplying 
the applicable amount from paragraph (a)(2) of this section by a 
fraction--
    (1) The numerator of which is the covered entity's branded 
prescription drug sales taken into account during the sales year 
(described in paragraph (c)(1) of this section); and
    (2) The denominator of which is the aggregate branded prescription 
drug sales taken into account for all covered entities during the same 
year (described in paragraph (c)(2) of this section).
    (e) Adjustment amount. For each fee year after 2011, in addition to 
the allocated fee computed under paragraph (d) of this section, the IRS 
will also calculate an adjustment amount that reflects the difference 
between the allocated fee determined for the covered entity in the 
immediately preceding fee year, using data from the second calendar year 
preceding that fee year, and what the allocated fee would have been for 
that entity for the immediately preceding fee year using data from the 
calendar year immediately preceding that fee year. For example, for 
2012, the adjustment amount for a covered entity will be the difference 
between the entity's 2011 allocated fee, using 2009 data, and what the 
2011 allocated fee would have been using 2010 data. Although the 
adjustment reflects a revision of the prior year's fee based on data 
from the year immediately preceding the prior fee year, the adjustment 
is only taken into account by adding it to or subtracting it from the 
allocated fee computed under paragraph (d) of this section for the 
current fee year to arrive at the total fee for the current fee year.



Sec. 51.6T  Notice of preliminary fee calculation (temporary).

    (a) Content of notice. For each sales year, the IRS will make a 
preliminary calculation of the fee for each covered entity as described 
in Sec. 51.5T. The IRS will notify each covered entity of its 
preliminary fee calculation for that sales year. The notification to a 
covered entity of its preliminary fee calculation will include--
    (1) The covered entity's allocated fee;
    (2) The covered entity's branded prescription drug sales, by NDC, by 
Program;
    (3) The covered entity's branded prescription drug sales taken into 
account after application of Sec. 51.5T(a)(3);
    (4) The aggregate branded prescription drug sales taken into account 
for all covered entities;
    (5) After the 2011 fee year, the covered entity's adjustment amount 
calculated as described in Sec. 51.5T(e); and

[[Page 14]]

    (6) A reference to the fee dispute resolution procedures set forth 
in guidance published in the Internal Revenue Bulletin.
    (b) Time of notice. The IRS will send each covered entity notice of 
its preliminary fee calculation by the date prescribed in guidance 
published in the Internal Revenue Bulletin.



Sec. 51.7T  Dispute resolution process (temporary).

    (a) In general. Upon receipt of its preliminary fee calculation, 
each covered entity will have an opportunity to dispute this calculation 
by submitting to the IRS an error report as described in this section. 
The IRS will provide its final determination with respect to error 
reports no later than the time the IRS provides a covered entity with a 
final fee calculation.
    (b) Program errors. To assert that there has been one or more errors 
in drug sales data, a covered entity must submit a separate error report 
for each Program with the asserted errors. Each report must include the 
following information--
    (1) Entity name, entity number (if applicable, from Part I (a) of 
the Form 8947), address, and Employer Identification Number (EIN) as 
previously reported on the Form 8947;
    (2) The name, telephone number, and e-mail address (if available) of 
one or more employees or representatives of the entity with whom the 
Agencies may discuss the claimed errors. A Form 2848, ``Power of 
Attorney and Declaration of Representative,'' must be filed with the 
error report; and
    (3) The name of the Program that reported the data, the NDC, the 
specific amount of sales data disputed, the proposed corrected amount, 
an explanation of why the Agency should use the proposed corrected data 
instead, and documentation of any Program drug sales data or other 
information used to establish the existence of any errors.
    (c) Errors other than Program drug sales errors. To assert that 
there has been one or more errors in the mathematical calculation of the 
fee, the rebate data, the listing of an NDC for an orphan drug, or any 
other error (other than Program drug sales data errors), a covered 
entity must submit one error report, separated into sections by type of 
error, and must include the following information--
    (1) Entity name, entity number (if applicable, from Part I (a) of 
the Form 8947), address, and EIN as previously reported on the Form 
8947;
    (2) The name, telephone number, and e-mail address (if available) of 
one or more employees or representatives of the entity with whom the IRS 
and/or the Agencies may discuss the claimed errors. A form 2848 must be 
filed with the error report;
    (3) For a mathematical calculation error, the specific calculation 
element(s) that the entity disputes and its proposed corrected 
calculation;
    (4) For a rebate data error, the NDC for the drug to which it 
relates; a discussion of whether the data used in the preliminary fee 
calculation matches previously reported Form 8947 data on rebates; and, 
if the data used in the preliminary fee calculation does match the Form 
8947 data, an explanation of why the Form 8947 data was erroneous and 
why the IRS should use the proposed corrected data instead;
    (5) For the listing of an NDC for an orphan drug, the name and NDC 
of the orphan drug; a discussion of whether the data used in the 
preliminary fee calculation matches previously reported Form 8947 data 
on orphan drugs; and, if the data used in the preliminary fee 
calculation does match the Form 8947 data, an explanation of why the 
Form 8947 data was erroneous and why the IRS should use the proposed 
corrected data instead;
    (6) For any other asserted error, an explanation of the nature of 
the error, how the error affects the fee calculation, an explanation of 
how the entity established that an error occurred, the proposed 
correction to the error, and an explanation of why the IRS or Agency 
should use the proposed corrected data instead;
    (7) If an entity is using data to establish the existence of an 
error and that data was not reported on Form 8947 or contained in the 
notification of the preliminary fee calculation, a description of what 
the data is, how the entity acquired the data, and who maintains it; and

[[Page 15]]

    (8) Documentation of any rebate and orphan drug data, or other 
information used to establish the existence of any errors.
    (d) Form, manner, and timing of submission. Each covered entity must 
submit its error report(s) in the form and manner that is prescribed in 
guidance published in the Internal Revenue Bulletin. This guidance will 
also prescribe the date by which each covered entity must submit its 
report(s).

[T.D. 9544, 76 FR 51249, Aug. 18, 2011; 76 FR 59897, Sept. 28, 2011]



Sec. 51.8T  Notification and payment of fee (temporary).

    (a) Notification of final fee calculation. No later than August 31st 
of each fee year, the IRS will send each covered entity its final fee 
calculation for that year. In any fee year, the IRS will base its final 
fee calculation on data provided to it by the Agencies as adjusted 
pursuant to the dispute resolution process. The notification to a 
covered entity of its final fee calculation will include--
    (1) The covered entity's allocated fee;
    (2) After the 2011 fee year, the covered entity's adjustment amount 
calculated as described in Sec. 51.5T(e);
    (3) The covered entity's branded prescription drug sales, by NDC, by 
Program;
    (4) The covered entity's branded prescription drug sales taken into 
account after application of Sec. 51.5T(a)(3);
    (5) The aggregate branded prescription drug sales taken into account 
for all covered entities; and
    (6) The final determination with respect to error reports.
    (b) Differences in preliminary fee calculation and final fee 
calculation. A covered entity's final fee calculation may differ from 
the covered entity's preliminary fee calculation because of changes made 
pursuant to the dispute resolution process described in Sec. 51.7T. 
Even if a covered entity did not file an error report described in Sec. 
51.7T, a covered entity's final fee may differ from a covered entity's 
preliminary fee because of a change in data reported by the Agencies 
after resolution of error reports, including a change in the aggregate 
prescription drug sales figure. A change in aggregate prescription drug 
sales data can affect each covered entity's fee because each covered 
entity's fee is a fraction of the aggregate fee collected from all 
covered entities. A covered entity's final fee may also differ from its 
preliminary fee calculation because the data used in the preliminary fee 
calculation may have contained inaccurate branded prescription drug 
sales information that was corrected or updated at the conclusion of the 
dispute resolution process.
    (c) Payment of final fee. Each covered entity must pay its final fee 
by September 30th of the fee year. For a controlled group, the payment 
must be made using the designated entity's EIN as reported on Form 8947. 
The fee must be paid by electronic funds transfer as required by Sec. 
51.6302-1T. There is no tax return to be filed for the fee.
    (d) Joint and several liability. In the case of a controlled group 
that is liable for the fee, all covered entities within the controlled 
group are jointly and severally liable for the fee. Accordingly, if a 
covered entity's fee is not paid, the IRS will separately assess each 
covered entity in the group for the full amount of the controlled 
group's fee.

[T.D. 9544, 76 FR 51249, Aug. 18, 2011; 76 FR 59897, Sept. 28, 2011]



Sec. 51.9T  Tax treatment of fee (temporary).

    (a) Treatment as an excise tax. The fee imposed by section 9008 is 
treated as an excise tax for purposes of subtitle F of the Code 
(sections 6001-7874). Thus, references in subtitle F to ``taxes imposed 
by this title,'' ``internal revenue tax,'' and similar references, are 
also references to the fee imposed by section 9008. For example, the fee 
imposed by section 9008 is assessed (section 6201), collected (sections 
6301, 6321, and 6331), enforced (section 7602), subject to examination 
and summons (section 7602), and subject to confidentiality rules 
(section 6103), in the same manner as taxes imposed by the Code.
    (b) Deficiency procedures. The deficiency procedures of sections 
6211-6216 do not apply to the fee imposed by section 9008.
    (c) Limitation on assessment. The IRS must assess the amount of the 
fee for

[[Page 16]]

any fee year within three years of September 30th of that fee year.
    (d) Application of section 275. The fee is treated as a tax 
described in section 275(a)(6) (relating to taxes for which no deduction 
is allowed).



Sec. 51.10T  Refund claims (temporary).

    Any claim for a refund of the fee must be made by the person that 
paid the fee to the government and must be made on Form 843, ``Claim for 
Refund and Request for Abatement,'' in accordance with the instructions 
for that form.



Sec. 51.11T  Effective/applicability date (temporary).

    Sections 51.1T through 51.10T apply to any fee on branded 
prescription drug sales that is due on or after September 30, 2011.



Sec. 51.12T  Expiration date (temporary).

    The applicability of Sec. Sec. 51.1T through 51.10T expires August 
15, 2014.



Sec. 51.6302-1T  Method of paying the branded prescription drug fee 
(temporary).

    (a) Fee to be paid by electronic funds transfer. Under the authority 
of section 6302(a), the fee imposed on branded prescription drug sales 
by section 9008 and Sec. 51.5T must be paid by electronic funds 
transfer as defined in Sec. 31.6302-1(h)(4)(i), as if the fee were a 
depository tax. For the time for paying the fee, see Sec. 51.8T.
    (b) Effective/applicability date. This section applies on and after 
August 18, 2011.
    (c) Expiration date. The applicability of this section expires 
August 15, 2014.



PART 52_ENVIRONMENTAL TAXES--Table of Contents



Sec.
52.0-1 Introduction.
52.4681-1 Taxes imposed with respect to ozone-depleting chemicals.
52.4682-1 Ozone-depleting chemicals.
52.4682-2 Qualifying sales.
52.4682-3 Imported taxable products.
52.4682-4 Floor stocks tax.
52.4682-5 Exports.

    Authority: 26 U.S.C. 7805.
    Section 52.4682-3 also issued under 26 U.S.C. 4682(c)(2);
    Section 52.4682-5 also issued under 26 U.S.C. 4662(e)(4).



Sec. 52.0-1  Introduction.

    The regulations in this part 52 are designated ``Environmental Tax 
Regulations.'' The regulations relate to the environmental taxes imposed 
by chapter 38 of the Internal Revenue Code. See part 40 of this chapter 
for regulations relating to returns, payments, and deposits of taxes 
imposed by chapter 38.

[T.D. 8442, 57 FR 48186, Oct. 22, 1992]



Sec. 52.4681-1  Taxes imposed with respect to ozone-depleting chemicals.

    (a) Taxes imposed. Sections 4681 and 4682 impose the following taxes 
with respect to ozone-depleting chemicals (ODCs):
    (1) Tax on ODCs. Section 4681(a)(1) imposes a tax on ODCs that are 
sold or used by the manufacturer or importer thereof. Except as 
otherwise provided in Sec. 52.4682-1 (relating to the tax on ODCs), the 
amount of the tax is equal to the product of--
    (i) The weight (in pounds) of the ODC;
    (ii) The base tax amount (determined under section 4681(b)(1) (B) or 
(C)) for the calendar year in which the sale or use occurs; and
    (iii) The ozone-depletion factor (determined under section 4682(b)) 
for the ODC.
    (2) Tax on imported taxable products. Section 4681(a)(2) imposes a 
tax on imported taxable products that are sold or used by the importer 
thereof. Except as otherwise provided in Sec. 52.4682-3 (relating to 
the tax on imported taxable products), the tax is computed by reference 
to the weight of the ODCs used as materials in the manufacture of the 
product. The amount of tax is equal to the tax that would have been 
imposed on the ODCs under section 4681(a)(1) if the ODCs had been sold 
in the United States on the date of the sale or use of the imported 
product. The weight of such ODCs is determined under Sec. 52.4682-3.
    (3) Floor stocks tax--(i) Imposition of tax. Section 4682(h) imposes 
a floor stocks tax on ODCs that--
    (A) Are held by any person other than the manufacturer or importer 
of the ODC on a date specified in paragraph (a)(3)(ii) of this section; 
and

[[Page 17]]

    (B) Are held on such date for sale or for use in further 
manufacture.
    (ii) Dates on which tax imposed. The floor stocks tax is imposed on 
January 1 of each calendar year after 1989.
    (iii) Amount of tax. Except as otherwise provided in Sec. 52.4682-4 
(relating to the floor stocks tax), the amount of the floor stocks tax 
is equal to the excess of--
    (A) The tax that would be imposed on the ODC under section 
4681(a)(1) if a sale or use of the ODC by its manufacturer or importer 
occurred on the date the floor stocks tax is imposed (the tentative tax 
amount), over
    (B) The sum of the taxes previously imposed (if any) on the ODC 
under sections 4681 and 4682.
    (b) Cross-references--(1) Tax on ODCs. Additional rules relating to 
the tax on ODCs are contained in Sec. Sec. 52.4682-1 and 52.4682-2.
    (2) Tax on imported taxable products. Additional rules relating to 
the tax on imported taxable products are contained in Sec. 52.4682-3.
    (3) Floor stocks tax. Additional rules relating to the floor stocks 
tax are contained in Sec. 52.4682-4.
    (4) Returns, payments, and deposits of tax. Rules requiring returns 
reporting the taxes imposed by sections 4681 and 4682 are contained in 
part 40 of this chapter. Part 40 of this chapter also provides rules 
relating to the use of Government depositaries and to the time for 
filing returns and making payments of tax.
    (c) Definitions of general application. The following definitions 
set forth the meaning of certain terms for purposes of the regulations 
under sections 4681 and 4682:
    (1) Ozone-depleting chemical. The term ``ozone-depleting chemical'' 
(ODC) means any chemical listed in section 4682(a)(2).
    (2) United States. The term ``United States'' has the meaning given 
such term by section 4612(a)(4). Under section 4612(a)(4)--
    (i) The term ``United States'' means the 50 States, the District of 
Columbia, the Commonwealth of Puerto Rico, any possession of the United 
States, the Commonwealth of the Northern Mariana Islands, and the Trust 
Territory of the Pacific Islands; and
    (ii) The term includes--
    (A) Submarine seabed and subsoil that would be treated as part of 
the United States (as defined in paragraph (c)(2)(i) of this section) 
under the principles of section 638 relating to continental shelf areas; 
and
    (B) Foreign trade zones of the United States.
    (3) Manufacture; manufacturer. The term ``manufacture'' when used 
with respect to any ODC or imported product includes its production, and 
the term ``manufacturer'' includes a producer.
    (4) Entry into United States for consumption, use, or warehousing--
(i) In general. Except as otherwise provided in this paragraph (c)(4), 
the term ``entered into the United States for consumption, use, or 
warehousing'' when used with respect to any goods means--
    (A) Brought into the customs territory of the United States (the 
customs territory) if applicable customs law requires that the goods be 
entered into the customs territory for consumption, use, or warehousing;
    (B) Admitted into a foreign trade zone for any purpose if like goods 
brought into the customs territory for such purpose would be entered 
into the customs territory for consumption, use, or warehousing; or
    (C) Imported into any other part of the United States (as defined in 
paragraph (c)(2) of this section) for any purpose if like goods brought 
into the customs territory for such purpose would be entered into the 
customs territory for consumption, use, or warehousing.
    (ii) Entry for transportation and exportation. Goods entered into 
the customs territory for transportation and exportation are not goods 
entered for consumption, use, or warehousing.
    (iii) Entries described in two or more provisions. In the case of 
any goods with respect to which entries are described in two or more 
provisions of paragraph (c)(4)(i) of this section, only the first such 
entry is taken into account. Thus, if the admission of goods into a 
foreign trade zone is an entry into the United States for consumption, 
use, or warehousing, the subsequent entry of such goods into the customs 
territory will not be treated as an

[[Page 18]]

entry into the United States for consumption, use, or warehousing.
    (iv) Certain imported products not entered for consumption, use, or 
warehousing. Imported products that are entered into the United States 
for consumption, use, or warehousing do not include any imported 
products that--
    (A) Are entered into the customs territory under Harmonized Tariff 
Schedule (HTS) heading 9801, 9802, 9803, or 9813;
    (B) Would, if entered into the customs territory, be entered under 
any such heading; or
    (C) Are brought into the United States by an individual if the 
product is brought in for use by the individual and is not expected to 
be used in a trade or business other than a trade or business of 
performing services as an employee.
    (5) Importer. The term ``importer'' means the person that first 
sells or uses goods after their entry into the United States for 
consumption, use, or warehousing (within the meaning of paragraph (c)(4) 
of this section).
    (6) Sale. The term ``sale'' means the transfer of title or of 
substantial incidents of ownership (whether or not delivery to, or 
payment by, the buyer has been made) for consideration which may include 
money, services, or property. The determination as to the time a sale 
occurs shall be made under applicable local law.
    (7) Use--(i) In general. Except as otherwise provided in regulations 
under sections 4681 and 4682, ODCs and imported taxable products are 
used when they are--
    (A) Used as a material in the manufacture of an article, whether by 
incorporation into such article, chemical transformation, release into 
the atmosphere, or otherwise; or
    (B) Put into service in a trade or business or for production of 
income.
    (ii) Loss, destruction, packaging, warehousing, and repair. The 
loss, destruction, packaging (including repackaging), warehousing, or 
repair of ODCs and imported taxable products is not a use of the ODC or 
product lost, destroyed, packaged, warehoused, or repaired.
    (iii) Cross-references to exceptions. For exceptions to the rule 
contained in paragraph (c)(7)(i) of this section, see--
    (A) Section 52.4682-1(b)(2)(iii) (relating to mixture elections), 
Sec. 52.4682-1(b)(2)(iv) (relating to mixtures for export), and Sec. 
52.4682-1(b)(2)(v) (relating to mixtures for use as a feedstock);
    (B) Section 52.4682-3(c)(2) (relating to the election to treat entry 
of an imported taxable product as use); and
    (C) Section 52.4682-3(c)(3) (relating to treating sale of an article 
incorporating an imported taxable product as the first sale or use of 
the product).
    (8) Pound. The term ``pound'' means a unit of weight that is equal 
to 16 avoirdupois ounces.
    (9) Post-1990 ODC; post-1989 ODC. The term ``post-1990 ODC'' means 
any ODC that is listed below Halon-2402 in the table contained in 
section 4682(a)(2). The term ``post-1989 ODC'' means any ODC other than 
a post-1990 ODC.
    (d) Effective date. Sections 52.4681-0, 52.4681-1, 52.4682-1, 
52.4682-2, 52.4682-3, and 52.4682-4 are effective as of January 1, 1990, 
and apply to--
    (1) Post-1989 ODCs that the manufacturer or importer thereof first 
sells or uses after December 31, 1989, and post-1990 ODCs that the 
manufacturer or importer thereof first sells or uses after December 31, 
1990;
    (2) Imported taxable products that the importer thereof first sells 
or uses after December 31, 1989 (but, in the case of products first sold 
or used before January 1, 1991, by taking into account only the post-
1989 ODCs used as materials in their manufacture); and
    (3) Post-1989 ODCs held for sale or for use in further manufacture 
by any person other than the manufacturer or importer thereof on January 
1, 1990, and post-1989 and post-1990 ODCs that are so held on January 1 
of each calendar year after 1990.

[T.D. 8370, 56 FR 56305, Nov. 4, 1991, as amended by T.D. 8442, 57 FR 
48186, Oct. 22, 1992; T.D. 8622, 60 FR 52849, Oct. 11, 1995]



Sec. 52.4682-1  Ozone-depleting chemicals.

    (a) Overview. This section provides rules relating to the tax 
imposed on ozone-depleting chemicals (ODCs) under section 4681, 
including rules for identifying taxable ODCs and determining when the 
tax is imposed, and

[[Page 19]]

rules prescribing special treatment for certain ODCs. See Sec. 52.4681-
1(a)(1) and (c) for general rules and definitions relating to the tax on 
ODCs.
    (b) Taxable ODCs; taxable event--(1) Taxable ODCs--(i) In general. 
Except as provided in paragraphs (c) through (g) of this section, an ODC 
is taxable if--
    (A) It is listed in section 4682(a)(2) on the date it is sold or 
used by its manufacturer or importer; and
    (B) It is manufactured in the United States or entered into the 
United States for consumption, use, or warehousing.
    (ii) Storage containers. An ODC described in paragraph (b)(1)(i) of 
this section is taxable without regard to the type or size of storage 
container in which the ODC is held.
    (iii) Example. The application of this paragraph (b)(1) may be 
illustrated by the following example:

    Example. A brings CFC-12, an ODC listed in section 4682(a)(2), into 
the customs territory and enters the CFC-12 for transportation and 
exportation. The ODC is not taxable because it is not entered for 
consumption, use, or warehousing. The ODC also would not be taxable if 
it were admitted to a foreign trade zone (rather than brought into the 
customs territory) for transportation and exportation.

    (2) Taxable event--(i) In general--(A) General rule. The tax on an 
ODC is imposed when the ODC is first sold or used (as defined in Sec. 
52.4681-1(c)(6) and (7)) by its manufacturer or importer.
    (B) Example. The application of this paragraph (b)(2)(i) may be 
illustrated by the following example:

    Example. A enters CFC-113, an ODC listed in section 4682(a)(2), into 
the United States for consumption, use, or warehousing. A warehouses the 
CFC-113 and then decides to ship the ODC to its factory outside the 
United States (as defined in Sec. 52.4681-1 (c)(2)). The CFC-113 is a 
taxable ODC because the requirements of paragraph (b)(1)(i) of this 
section have been met. However, tax is not imposed on the ODC because 
there is no taxable event. A did not sell the ODC and, under Sec. 
52.4681-1(c)(7), warehousing is not a use.

    (ii) Mixtures. Except as provided in paragraphs (b)(2)(iii), (iv), 
and (v) of this section, the creation of a mixture containing two or 
more ingredients is treated as a taxable use of the ODCs contained in 
the mixture. For this purpose, a mixture cannot be represented by a 
chemical formula, and an ODC is contained in a mixture only if the 
chemical identity of the ODC is not changed. Thus, except as provided in 
paragraphs (b)(2)(iii), (iv), and (v) of this section--
    (A) The tax on the post-1989 ODCs (as defined in Sec. 52.4681-
1(c)(9)) contained in mixtures created after December 31, 1989, or on 
the post-1990 ODCs (as defined in Sec. 52.4681-1(c)(9)) contained in 
mixtures created after December 31, 1990, is imposed when the mixture is 
created and not on any subsequent sale or use of the mixture; and
    (B) No tax is imposed under section 4681 on the post-1989 ODCs 
contained in mixtures created before January 1, 1990, or on the post-
1990 ODCs contained in mixtures created before January 1, 1991.
    (iii) Mixture elections--(A) Permitted elections. The only elections 
permitted under this paragraph (b)(2)(iii) are--
    (1) An election for the first calendar quarter beginning after 
December 31, 1989, and all subsequent periods (the 1990 election); and
    (2) An election for the first calendar quarter beginning after 
December 31, 1990, and all subsequent periods (the 1991 election).
    (B) In general. A manufacturer or importer may elect to treat the 
sale or use of mixtures containing ODCs as the first sale or use of the 
ODCs contained in the mixtures. If a 1990 election is made under this 
paragraph (b)(2)(iii), the tax on post-1989 ODCs contained in a mixture 
sold or used after December 31, 1989 (including any such mixture created 
before January 1, 1990) is imposed on the date of such sale or use. 
Similarly, if a 1991 election is made under this paragraph (b)(2)(iii), 
the tax on post-1990 ODCs contained in a mixture sold or used after 
December 31, 1990 (including any such mixture created before January 1, 
1991) is imposed on the date of such sale or use.
    (C) Applicability of elections. An election under this paragraph 
(b)(2)(iii) applies--
    (1) In the case of a 1990 election, to all post-1989 ODCs contained 
in mixtures sold or used by the manufacturer or importer after December 
31, 1989 (including any such mixture created before January 1, 1990); 
and

[[Page 20]]

    (2) In the case of a 1991 election, to all post-1990 ODCs contained 
in mixtures sold or used by the manufacturer or importer after December 
31, 1990 (including any such mixture created before January 1, 1991).
    (D) Making the election; revocation. An election under this 
paragraph (b)(2)(iii) shall be made in accordance with the instructions 
for the return on which the manufacturer or importer reports liability 
for tax under section 4681. After October 9, 1990, the election may be 
revoked only with the consent of the Commissioner.
    (iv) Special rule for exports. The creation of a mixture for export 
is not a taxable use of the ODCs contained in the mixture. If a 
manufacturer or importer sells a mixture for export, Sec. 52.4682-5 
applies to the ODCs contained in the mixture. See Sec. 52.4682-5(e) for 
rules relating to liability of a purchaser for tax if the mixture is not 
exported.
    (v) Special rule for use as a feedstock. The creation of a mixture 
for use as a feedstock (within the meaning of paragraph (c) of this 
section) is not a taxable use of the ODCs contained in the mixture.
    (c) ODCs used as a feedstock--(1) Exemption from tax. No tax is 
imposed on an ODC if the manufacturer or importer of the ODC--
    (i) Uses the ODC as a feedstock in the manufacture of another 
chemical; or
    (ii) Sells the ODC in a qualifying sale (within the meaning of 
paragraph (c)(4) of this section) for use as a feedstock.
    (2) Excess payments--(i) In general. Under section 4682(d)(2)(B), a 
credit or refund is allowed to a person if--
    (A) The person uses an ODC as a feedstock; and
    (B) The amount of any tax paid with respect to the ODC under section 
4681 or 4682 was not determined under section 4682(d)(2)(A).
    (ii) Procedural rules. See section 6402 and the regulations 
thereunder for rules relating to claiming a credit or refund of tax paid 
with respect to ODCs that are used as a feedstock. A credit against the 
income tax is not allowed for the amount determined under section 
4682(d)(2)(B).
    (3) Definition. An ODC is used as a feedstock only if the ODC is 
entirely consumed (except for trace amounts) in the manufacture of 
another chemical. Thus, the transformation of an ODC into one or more 
new compounds (such as the transformation of CFC-113 into 
chlorotrifluoroethylene (CTFE or 1113), of CFC-113 into CFC-115 and CFC-
116, or of carbon tetrachloride into hydrochloric acid during petroleum 
refining or incineration) is treated as use as a feedstock. On the other 
hand, the ODCs used in a mixture (including an azeotrope such as R-500 
or R-502) are not used as a feedstock.
    (4) Qualifying sale. A sale of ODCs for use as a feedstock is a 
qualifying sale if the requirements of Sec. 52.4682-2(b)(1) are 
satisfied with respect to such sale.
    (d) ODCs used in the manufacture of rigid foam insulation--(1) 
Phase-in of tax--(i) In general. The amount of tax imposed on an ODC is 
determined under section 4682(g) if the manufacturer or importer of the 
ODC--
    (A) Uses the ODC during 1990, 1991, 1992, or 1993 in the manufacture 
of rigid foam insulation; or
    (B) Sells the ODC in a qualifying sale (within the meaning of 
paragraph (d)(5) of this section) during 1990, 1991, 1992, or 1993.
    (ii) Amount of tax. Under section 4682(g), ODCs described in 
paragraph (d)(1)(i) of this section are not taxed if sold or used during 
1990 and are taxed at a reduced rate if sold or used during 1991, 1992, 
or 1993.
    (2) Excess payments--(i) In general. Under section 4682(g)(3), a 
credit against income tax or a refund is allowed to a person if--
    (A) The person uses an ODC during 1990, 1991, 1992, or 1993 in the 
manufacture of rigid foam insulation; and
    (B) The amount of any tax paid with respect to the ODC under section 
4681 or 4682 was not determined under section 4682(g).
    (ii) Procedural rules--(A) The amount determined under section 
4682(g)(3) shall be treated as a credit described in section 34(a) 
(relating to credits for gasoline and special fuels) unless a claim for 
refund has been filed.
    (B) See section 6402 and the regulations thereunder for rules 
relating to claiming a credit or refund of the tax paid with respect to 
ODCs that are

[[Page 21]]

used in the manufacture of rigid foam insulation.
    (3) Definition--(i) Rigid foam insulation. The term ``rigid foam 
insulation'' means any rigid foam that is designed for use as thermal 
insulation in buildings, equipment, appliances, tanks, railcars, trucks, 
or vessels, or on pipes, including any such rigid foam actually used for 
purposes other than insulation. Information such as test reports on R-
values and advertising material reflecting R-value claims for a 
particular rigid foam may be used to show that such rigid foam is 
designed for use as thermal insulation.
    (ii) Rigid foam--(A) In general. The term ``rigid foam'' means any 
closed cell polymeric foam (whether or not rigid) in which 
chlorofluorocarbons are used to fill voids within the polymer.
    (B) Examples of rigid foam products. Rigid foam includes extruded 
polystyrene foam, polyisocyanurate foam, spray and pour-in-place 
polyurethane foam, polyethylene foam, phenolic foam, and any other 
product that the Commissioner identifies as rigid foam in a 
pronouncement of general applicability. The form of a product identified 
under this paragraph (d)(3)(ii)(B) does not affect its character as 
rigid foam. Thus, such products are rigid foam whether in the form of a 
board, sheet, backer rod, or wrapping, or in a form applied by spraying, 
pouring, or frothing.
    (4) Use in manufacture. An ODC is used in the manufacture of rigid 
foam insulation if it is incorporated into such product or is expended 
as a propellant or otherwise in the manufacture or application of such 
product.
    (5) Qualifying sale. A sale of an ODC for use in the manufacture of 
rigid foam insulation is a qualifying sale if the requirements of Sec. 
52.4682-2(b)(2) are satisfied with respect to such sale.
    (e) Halons; phase-in of tax. The amount of tax imposed on Halon-
1211, Halon-1301, or Halon-2402 (Halons) is determined under section 
4682(g) if the manufacturer or importer of Halons sells or uses Halons 
during 1990, 1991, 1992, or 1993. Under section 4682(g), Halons are not 
taxed if sold or used during 1990 and are taxed at a reduced rate if 
sold or used during 1991, 1992, or 1993.
    (f) Methyl chloroform; reduced rate of tax in 1993. The amount of 
tax imposed on methyl chloroform is determined under section 4682(g)(5) 
if the manufacturer or importer of the methyl chloroform sells or uses 
it during 1993.
    (g) ODCs used as medical sterilants--(1) Phase-in of tax. The amount 
of tax imposed on an ODC is determined under section 4682(g)(4) if the 
manufacturer or importer of the ODC--
    (i) Uses the ODC during 1993 as a medical sterilant; or
    (ii) Sells the ODC in a qualifying sale (within the meaning of 
paragraph (g)(4) of this section) during 1993.
    (2) Excess payments--(i) In general. Under section 4682(g)(4)(B), a 
credit against income tax (without interest) or a refund of tax (without 
interest) is allowed to a person if--
    (A) The person uses an ODC during 1993 as a medical sterilant; and
    (B) The amount of any tax paid with respect to the ODC under section 
4681 or 4682 exceeds the amount that would have been determined under 
section 4682(g)(4).
    (ii) Amount of credit or refund. The amount of credit or refund of 
tax is equal to the excess of--
    (A) The tax that was paid with respect to the ODCs under sections 
4681 and 4682; over
    (B) The tax that would have been imposed under section 4682(g)(4).
    (iii) Procedural rules. (A) The amount determined under section 
4682(g)(4)(B) and paragraph (g)(2)(ii) of this section is treated as a 
credit described in section 34(a) (relating to credits for gasoline and 
special fuels) unless a claim for refund has been filed.
    (B) See section 6402 and the regulations under that section for 
procedural rules relating to claiming a credit or refund of tax.
    (3) Definition of use as a medical sterilant. An ODC is used as a 
medical sterilant if it is used in the manufacture of sterilant gas.
    (4) Qualifying sale. A sale of an ODC for use as a medical sterilant 
is a qualifying sale if the requirements of Sec. 52.4682-2(b)(3) are 
satisfied with respect to the sale.
    (h) ODCs used as propellants in metered-dose inhalers--(1) Reduced 
rate of tax. The amount of tax imposed on an

[[Page 22]]

ODC is determined under section 4682(g)(4) if the manufacturer or 
importer of the ODC--
    (i) Uses the ODC after 1992 as a propellant in a metered-dose 
inhaler; or
    (ii) Sells the ODC in a qualifying sale (within the meaning of 
paragraph (h)(4) of this section) after 1992.
    (2) Excess payments--(i) In general. Under section 4682(g)(4)(B), a 
credit against income tax (without interest) or a refund of tax (without 
interest) is allowed to a person if--
    (A) The person uses an ODC after 1992 as a propellant in a metered-
dose inhaler; and
    (B) The amount of any tax paid with respect to the ODC under section 
4681 or 4682 exceeds the amount that would have been determined under 
section 4682(g)(4).
    (ii) Amount of credit or refund. The amount of credit or refund of 
tax is equal to the excess of--
    (A) The tax that was paid with respect to the ODCs under sections 
4681 and 4682; over
    (B) The tax that would have been imposed under section 4682(g)(4).
    (iii) Procedural rules--(A) The amount determined under section 
4682(g)(4)(B) and paragraph (h)(2)(ii) of this section is treated as a 
credit described in section 34(a) (relating to credits for gasoline and 
special fuels) unless a claim for refund has been filed.
    (B) See section 6402 and the regulations under that section for 
procedural rules relating to claiming a credit or refund of tax.
    (3) Definition of metered-dose inhaler. A metered-dose inhaler is an 
aerosol device that delivers a precisely-measured dose of a therapeutic 
drug.
    (4) Qualifying sale. A sale of an ODC for use as a propellant for a 
metered-dose inhaler is a qualifying sale if the requirements of Sec. 
52.4682-2(b)(4) are satisfied with respect to the sale.
    (i) [Reserved]
    (j) Exports; cross-reference. For the treatment of exports of ODCs, 
see Sec. 52.4682-5.
    (k) Recycling. [Reserved]

[T.D. 8370, 56 FR 56307, Nov. 4, 1991, as amended by T.D. 8622, 60 FR 
52849, Oct. 11, 1995]



Sec. 52.4682-2  Qualifying sales.

    (a) In general--(1) Special rules applicable to certain sales. 
Special rules apply to sales of ODCs in the following cases:
    (i) Under section 4682(d)(2), Sec. 52.4682-1(c), and Sec. 52.4682-
4(b)(2)(v) (relating to ODCs used as a feedstock), ODCs sold in 
qualifying sales are not taxed.
    (ii) Under section 4682(g), Sec. 52.4682-1(d), and Sec. 52.4682-
4(d)(2) (relating to ODCs used in the manufacture of rigid foam 
insulation), ODCs sold in qualifying sales are not taxed in 1990 and are 
taxed at a reduced rate in 1991, 1992, and 1993.
    (iii) Under section 4682(g)(4) and Sec. 52.4682-1(g) (relating to 
ODCs used as medical sterilants), ODCs sold in qualifying sales are 
taxed at a reduced rate in 1993.
    (iv) Under section 4682(g)(4) and Sec. 52.4682-1(h) (relating to 
ODCs used as propellants in metered-dose inhalers), ODCs sold in 
qualifying sales are taxed at a reduced rate in years after 1992.
    (2) Qualifying sales. A sale of ODCs is not a qualifying sale unless 
the requirements of this section are satisfied. Although registration 
with the Internal Revenue Service is not required to establish that a 
sale of ODCs is a qualifying sale, the certificates required by this 
section shall be made available for inspection by internal revenue 
agents and officers.
    (b) Requirements for qualification--(1) Use as a feedstock. A sale 
of ODCs is a qualifying sale for purposes of Sec. Sec. 52.4682-1(c) and 
52.4682-4(b)(2)(v) if the manufacturer or importer of the ODCs--
    (i) Obtains a certificate in substantially the form set forth in 
paragraph (d)(2) of this section from the purchaser of the ODCs; and
    (ii) Relies on the certificate in good faith.
    (2) Use in the manufacture of rigid foam insulation. A sale of ODCs 
is a qualifying sale for purposes of Sec. Sec. 52.4682-1(d) and 
52.4682-4(d)(2) if the manufacturer or importer of the ODCs--
    (i) Obtains a certificate in substantially the form set forth in 
paragraph (d)(3) of this section from the purchaser of the ODCs; and
    (ii) Relies on the certificate in good faith.

[[Page 23]]

    (3) Use as medical sterilants. A sale of ODCs is a qualifying sale 
for purposes of Sec. 52.4682-1(g) if the manufacturer or importer of 
the ODCs--
    (i) Obtains a certificate in substantially the form set forth in 
paragraph (d)(4) of this section from the purchaser of the ODCs; and
    (ii) Relies on the certificate in good faith.
    (4) Use as propellants in metered-dose inhalers. A sale of ODCs is a 
qualifying sale for purposes of Sec. Sec. 52.4682-1(h) and 52.4682-
4(b)(2)(vii) if the manufacturer or importer of the ODCs--
    (i) Obtains a certificate in substantially the form set forth in 
paragraph (d)(5) of this section from the purchaser of the ODCs; and
    (ii) Relies on the certificate in good faith.
    (c) Good faith reliance--(1) In general. The requirements of 
paragraph (b) of this section are not satisfied with respect to a sale 
of ODCs and the sale is not a qualifying sale if at the time of the 
sale--
    (i) The manufacturer or importer has reason to believe that the 
purchaser will use the ODCs other than for the purpose set forth in the 
certificate; or
    (ii) The Internal Revenue Service has notified the manufacturer or 
importer that the purchaser's right to provide a certificate has been 
withdrawn.
    (2) Withdrawal of right to provide a certificate. The Internal 
Revenue Service may withdraw the right of a purchaser to provide a 
certificate to its supplier if such purchaser uses the ODCs to which its 
certificate applies other than for the purpose set forth in such 
certificate, or otherwise fails to comply with the terms of the 
certificate. The Internal Revenue Service may notify the supplier to 
whom the purchaser provided the certificate that the purchaser's right 
to provide a certificate has been withdrawn.
    (d) Certificate--(1) In general--(i) Rules relating to all 
certificates. This paragraph (d) sets forth certificates that satisfy 
the requirements of paragraphs (b)(1) through (4) of this section. The 
certificate shall consist of a statement executed and signed under 
penalties of perjury by a person with authority to bind the purchaser. A 
certificate provided under paragraph (d)(2) or (5) of this section may 
apply to a single purchase or to multiple purchases and need not specify 
an expiration date. A certificate provided under paragraph (d)(3) or (4) 
of this section may apply to a single purchase or multiple purchases, 
and will expire as of December 31, 1993, unless an earlier expiration 
date is specified in the certificate. A new certificate must be given to 
the supplier if any information on the current certificate changes. The 
certificate may be included as part of any business records normally 
used to document a sale.
    (ii) Special rule relating to certificates executed before January 
1, 1992. Certificates provided under this paragraph (d)(2) and executed 
before January 1, 1992, satisfy the requirements of paragraph (b) of 
this section if they are in substantially the same form as certificates 
set forth in Sec. 52.4682-2T.
    (2) Certificate relating to ODCs used as a feedstock--(i) ODCs that 
will be resold for use by the second purchaser as a feedstock. If the 
purchaser will resell the ODCs to a second purchaser for use by such 
second purchaser as a feedstock, the certificate provided by the 
purchaser must be in substantially the following form:

Certificate of Purchaser of Chemicals That Will Be Resold for Use by the 
                     Second Purchaser as a Feedstock

(To support tax-free sales under section 4682(d)(2) of the Internal 
Revenue Code.)

Date____________________________________________________________________
    The undersigned purchaser (``Purchaser'') hereby certifies the 
following under penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased from

________________________________________________________________________
(name and address of seller)

will be resold by Purchaser to persons (Second Purchasers) that certify 
to Purchaser that they are purchasing the ozone-depleting chemicals for 
use as a feedstock (as defined in Sec. 52.4682-1(c)(3) of the 
Environmental Tax Regulations).

------------------------------------------------------------------------
                  Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................
CFC-12.....................................
CFC-113....................................
CFC-114....................................
CFC-115....................................
Carbon tetrachloride.......................
Methyl chloroform..........................
Other (specify)............................
------------------------------------------------------------------------


[[Page 24]]

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following Purchaser account 
number(s):
________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following purchase order(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ One or more shipments to Purchaser identified as follows:

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________
    Purchaser will not claim a credit or refund under section 
4682(d)(2)(B) of the Internal Revenue Code for any ozone-depleting 
chemicals covered by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the 
purpose set forth in this certificate may result in the withdrawal by 
the Internal Revenue Service of Purchaser's right to provide a 
certificate.
    Purchaser will retain the business records needed to document the 
sales covered by this certificate and will make such records available 
for inspection by Government officers. Purchaser also will retain and 
make available for inspection by Government officers the certificates of 
its Second Purchasers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn. In addition, the 
Internal Revenue Service has not notified Purchaser that the right to 
provide a certificate has been withdrawn from any Second Purchaser who 
will purchase ozone-depleting chemicals to which this certificate 
applies.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Signature

________________________________________________________________________
Printed or typed name of person signing

________________________________________________________________________
Title of person signing

________________________________________________________________________
Name of Purchaser

________________________________________________________________________
Address

________________________________________________________________________

________________________________________________________________________

Taxpayer Identifying Number

    (ii) ODCs that will be used by the purchaser as a feedstock. If the 
purchaser will use the ODCs as a feedstock, the certificate provided by 
the purchaser must be in substantially the following form:

Certificate of Purchaser of Chemicals That Will Be Used by the Purchaser 
                             as a Feedstock

(To support tax-free sales under section 4682(d)(2) of the Internal 
Revenue Code.)

Date____________________________________________________________________
    The undersigned purchaser (``Purchaser'') hereby certifies the 
following under penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased from
________________________________________________________________________
(name and address of seller)

will be used by Purchaser as a feedstock (as defined in Sec. 52.4682-
1(c)(3) of the Environmental Tax Regulations).

------------------------------------------------------------------------
                                                        Kilograms to be
             Product                   Percentage         transformed
------------------------------------------------------------------------
CFC-11...........................
CFC-12...........................
CFC-113..........................
CFC-114..........................
CFC-115..........................
Carbon tetrachloride.............
Methyl chloroform................
Other (specify)..................
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):
------ All shipments to Purchaser at the following location(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following Purchaser account 
number(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following purchase order(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ One or more shipments to Purchaser identified as follows:

________________________________________________________________________


[[Page 25]]

________________________________________________________________________
________________________________________________________________________

________________________________________________________________________
    Purchaser will not claim a credit or refund under section 
4682(d)(2)(B) of the Internal Revenue Code for any ozone-depleting 
chemicals covered by this certificate.
    Purchaser understands that any use of the ozone-depleting chemicals 
to which this certificate applies other than as a feedstock may result 
in the withdrawal by the Internal Revenue Service of Purchaser's right 
to provide a certificate.
    Purchaser will retain the business records needed to document the 
use as a feedstock of the ozone-depleting chemicals to which this 
certificate applies and will make such records available for inspection 
by Government officers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.

________________________________________________________________________
Signature

________________________________________________________________________
Printed or typed name of person signing

________________________________________________________________________
Title of person signing

________________________________________________________________________
Name of Purchaser

________________________________________________________________________
Address

________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number

    (3) Certificate relating to ODCs used in the manufacture of rigid 
foam insulation--(i) ODCs that will be resold to a second purchaser for 
use by the second purchaser in the manufacture of rigid foam insulation. 
If the purchaser will resell the ODCs to a second purchaser for use by 
such second purchaser in the manufacture of rigid foam insulation, the 
certificate provided by the purchaser must be in substantially the 
following form:

Certificate of Purchaser of Chemicals That Will Be Resold for Use by the 
      Second Purchaser in the Manufacture of Rigid Foam Insulation

(To support tax-free or tax-reduced sales under section 4682(g) of the 
Internal Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
(not after 12/31/93)

    The undersigned purchaser (``Purchaser'') hereby certifies the 
following under penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased from

________________________________________________________________________
(name and address of seller)

will be resold by Purchaser to persons (Second Purchasers) that certify 
to Purchaser that they are purchasing the ozone-depleting chemicals for 
use in the manufacture of rigid foam insulation (as defined in Sec. 
52.4682-1(d)(3) and (4) of the Environmental Tax Regulations).

------------------------------------------------------------------------
                  Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................
CFC-12.....................................
CFC-113....................................
CFC-114....................................
CFC-115....................................
Carbon tetrachloride.......................
Methyl chloroform..........................
Other (specify)............................
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

 ------ All shipments to Purchaser under the following Purchaser account 
number(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following purchase order(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ One or more shipments to Purchaser identified as follows:

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(3) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the 
purpose set forth in this certificate may result in the withdrawal by 
the Internal Revenue Service of Purchaser's right to provide a 
certificate.
    Purchaser will retain the business records needed to document the 
sales covered by this certificate and will make such records available 
for inspection by Government officers.

[[Page 26]]

Purchaser also will retain and make available for inspection by 
Government officers the certificates of its Second Purchasers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn. In addition, the 
Internal Revenue Service has not notified Purchaser that the right to 
provide a certificate has been withdrawn from any Second Purchaser who 
will purchase ozone-depleting chemicals to which this certificate 
applies.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.

________________________________________________________________________
Signature

________________________________________________________________________
Printed or typed name of person signing

________________________________________________________________________
Title of person signing

________________________________________________________________________
Name of Purchaser

________________________________________________________________________
Address

________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number

    (ii) ODCs that will be used by the purchaser in the manufacture of 
rigid foam insulation. If the purchaser will use the ODCs in the 
manufacture of rigid foam insulation, the certificate provided by the 
purchaser must be in substantially the following form:

Certificate of Purchaser of Chemicals That Will Be Used by the Purchaser 
               in the Manufacture of Rigid Foam Insulation

(To support tax-free or tax-reduced sales under section 4682(g) of the 
Internal Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
(not after 12/31/93)

    The undersigned purchaser (``Purchaser'') hereby certifies the 
following under penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased from

________________________________________________________________________
(name and address of seller)

will be used by Purchaser in the manufacture of rigid foam insulation 
(as defined in Sec. 52.4682-1(d) (3) and (4) of the Environmental Tax 
Regulations).

------------------------------------------------------------------------
                  Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................
CFC-12.....................................
CFC-113....................................
CFC-114....................................
CFC-115....................................
Carbon tetrachloride.......................
Methyl chloroform..........................
Other (specify)............................
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following Purchaser account 
number(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following purchase order(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ One or more shipments to Purchaser identified as follows:

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(3) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than in the 
manufacture of rigid foam insulation may result in the withdrawal by the 
Internal Revenue Service of Purchaser's right to provide a certificate.
    Purchaser will retain the business records needed to document the 
use in the manufacture of rigid foam insulation of the ozone-depleting 
chemicals to which this certificate applies and will make such records 
available for inspection by Government officers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.

________________________________________________________________________
Signature

________________________________________________________________________
Printed or typed name of person signing


[[Page 27]]


________________________________________________________________________
Title of person signing
________________________________________________________________________
Name of Purchaser

________________________________________________________________________
Address

________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number

    (4) Certificate relating to ODCs used as medical sterilants--(i) 
ODCs that will be resold for use by the second purchaser as medical 
sterilants. If the purchaser will resell the ODCs to a second purchaser 
for use by such second purchaser as medical sterilants, the certificate 
provided by the purchaser must be in substantially the following form:

CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE RESOLD FOR USE BY THE 
                 SECOND PURCHASER AS MEDICAL STERILANTS

 (To support tax-reduced sales under section 4682(g)(4) of the Internal 
                             Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
 (not after 12/31/93)
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased 
from:

________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)

will be resold by Purchaser to persons (Second Purchasers) that certify 
to Purchaser that they are purchasing the ozone-depleting chemicals for 
use as medical sterilants (as defined in Sec. 52.4682-1(g)(3) of the 
Environmental Tax Regulations).

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-12.....................................................   ----------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account 
          number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(4) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the 
purpose set forth in this certificate may result in the withdrawal by 
the Internal Revenue Service of Purchaser's right to provide a 
certificate.
    Purchaser will retain the business records needed to document the 
sales covered by this certificate and will make such records available 
for inspection by Government officers. Purchaser also will retain and 
make available for inspection by Government officers the certificates of 
its Second Purchasers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn. In addition, the 
Internal Revenue Service has not notified Purchaser that the right to 
provide a certificate has been withdrawn from any Second Purchaser who 
will purchase ozone-depleting chemicals to which this certificate 
applies.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

    (ii) ODCs that will be used by the purchaser as medical sterilants. 
If the purchaser will use the ODCs as medical sterilants, the 
certificate provided by the purchaser must be in substantially the 
following form:

[[Page 28]]

CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE USED BY THE PURCHASER 
                          AS MEDICAL STERILANTS

 (To support tax-reduced sales under section 4682(g)(4) of the Internal 
                             Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
 (not after 12/31/93)
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased 
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)

will be used by Purchaser as medical sterilants (as defined in Sec. 
52.4682-1(g)(3) of the Environmental Tax Regulations).

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-12.....................................................   ----------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account 
          number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(4) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than as 
medical sterilants may result in the withdrawal by the Internal Revenue 
Service of Purchaser's right to provide a certificate.
    Purchaser will retain the business records needed to document the 
use as medical sterilants of the ozone-depleting chemicals to which this 
certificate applies and will make such records available for inspection 
by Government officers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

    (5) Certificate relating to ODCs used as propellants in metered-dose 
inhalers--(i) ODCs that will be resold for use by the second purchaser 
as propellants in metered-dose inhalers. If the purchaser will resell 
the ODCs to a second purchaser for use by such second purchaser as 
propellants in metered-dose inhalers, the certificate provided by the 
purchaser must be in substantially the following form:

CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE RESOLD FOR USE BY THE 
        SECOND PURCHASER AS PROPELLANTS IN METERED-DOSE INHALERS

 (To support tax-reduced sales under section 4682(g)(4) of the Internal 
                             Revenue Code.)

Date____________________________________________________________________
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased 
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)

will be resold by Purchaser to persons (Second Purchasers) that certify 
to Purchaser that they are purchasing the ozone-depleting chemicals for 
use as propellants in metered-dose inhalers (as defined in Sec. 
52.4682-1(h)(3) of the Environmental Tax Regulations).

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................................     --------
CFC-12.....................................................     --------
CFC-114....................................................     --------
------------------------------------------------------------------------


[[Page 29]]

    This certificate applies to (check and complete as applicable):

-------- All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following Purchaser 
          account number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following purchase 
          order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(4) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the 
purpose set forth in this certificate may result in the withdrawal by 
the Internal Revenue Service of Purchaser's right to provide a 
certificate.
    Purchaser will retain the business records needed to document the 
sales covered by this certificate and will make such records available 
for inspection by Government officers. Purchaser also will retain and 
make available for inspection by Government officers the certificates of 
its Second Purchasers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn. In addition, the 
Internal Revenue Service has not notified Purchaser that the right to 
provide a certificate has been withdrawn from any Second Purchaser who 
will purchase ozone-depleting chemicals to which this certificate 
applies.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

    (ii) ODCs that will be used by the purchaser as propellants in 
metered-dose inhalers. If the purchaser will use the ODCs as propellants 
in metered-dose inhalers, the certificate provided by the purchaser must 
be in substantially the following form:

CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE USED BY THE PURCHASER 
                 AS PROPELLANTS IN METERED-DOSE INHALERS

 (To support tax-reduced sales under section 4682(g)(4) of the Internal 
                             Revenue Code.)

Date____________________________________________________________________
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased 
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)

will be used by Purchaser as propellants in metered-dose inhalers (as 
defined in Sec. 52.4682-1(h)(3) of the Environmental Tax Regulations).

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................................     --------
CFC-12.....................................................     --------
CFC-114....................................................     --------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

-------- All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following Purchaser 
          account number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following purchase 
          order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(4) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.

[[Page 30]]

    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than as 
propellants in metered-dose inhalers may result in the withdrawal by the 
Internal Revenue Service of Purchaser's right to provide a certificate.
    Purchaser will retain the business records needed to document the 
use as propellants in metered-dose inhalers of the ozone-depleting 
chemicals to which this certificate applies and will make such records 
available for inspection by Government officers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

[T.D. 8370, 56 FR 56308, Nov. 4, 1991, as amended by T.D. 8622, 60 FR 
52850, Oct. 11, 1995]



Sec. 52.4682-3  Imported taxable products.

    (a) Overview; references to Tables; special rule for 1990--(1) 
Overview. This section provides rules relating to the tax imposed on 
imported taxable products under section 4681, including rules for 
identifying imported taxable products, determining the weight of the 
ozone-depleting chemicals (ODCs) used as materials in the manufacture of 
such products, and computing the amount of tax on such products. See 
Sec. 52.4681-1(a)(2) and (c) for general rules and definitions relating 
to the tax on imported taxable products.
    (2) References to Tables. When used in this section--
    (i) The term Imported Products Table (Table) refers to the Table set 
forth in paragraph (f)(6) of this section; and
    (ii) The term current Imported Products Table (current Table) used 
with respect to a product refers to the Table in effect on the date such 
product is first sold or used by the importer thereof.
    (3) Special rule for 1990. In the case of products first sold or 
used before January 1, 1991, post-1990 ODCs (as defined in Sec. 
52.4681-1(c)(9)) shall not be taken into account in applying the rules 
of this section.
    (b) Imported taxable products--(1) In general--(i) Rule. Except as 
provided in paragraph (b)(2) of this section, the term ``imported 
taxable product'' means any product that--
    (A) Is entered into the United States for consumption, use, or 
warehousing; and
    (B) Is listed in the current Table.
    (ii) Example. The application of this paragraph (b)(1) may be 
illustrated by the following example:

    Example. A brings a light truck with a Harmonized Tariff Schedule 
classification of 8704 into the customs territory and enters the truck 
for transportation and exportation. Although the truck is listed in the 
current Table, it is not an imported taxable product because it is not 
entered for consumption, use, or warehousing. The truck also would not 
be an imported taxable product if it were admitted to a foreign trade 
zone (rather than brought into the customs territory) for transportation 
and exportation.

    (2) Exceptions--(i) In general. A product is not treated as an 
imported taxable product if--
    (A) The product is listed in Part I of the current Table and the 
adjusted tax with respect to the product is de minimis (within the 
meaning of paragraph (b)(2)(ii) of this section); or
    (B) The product is listed in Part II of the current Table, the 
adjusted tax with respect to the product is de minimis (within the 
meaning of paragraph (b)(2)(ii) of this section), and the ODCs (other 
than methyl chloroform) used as materials in the manufacture of the 
product were not used for purposes of refrigeration or air conditioning, 
creating an aerosol or foam, or manufacturing electronic components.
    (ii) De minimis adjusted tax. The adjusted tax with respect to a 
product is de minimis if such tax is less than one/tenth of one percent 
of the importer's cost of acquiring such product. The term adjusted tax 
means the tax that would be imposed under section 468l on the ODCs used 
as materials in the manufacture of such product if such ODCs

[[Page 31]]

were sold in the United States and the base tax amount were $1.00.
    (c) Taxable event--(1) In general. Except as otherwise provided in 
paragraphs (c) (2) and (3) of this section, the tax on an imported 
taxable product is imposed when the product is first sold or used (as 
defined in Sec. 52.4681-1(c) (6) and (7)) by its importer. Thus, for 
example, imported taxable products that are warehoused or repackaged 
after entry and then exported without being sold or used in the United 
States are not subject to tax.
    (2) Election to treat importation as use--(i) In general. An 
importer may elect to treat the entry of products into the United States 
as the use of such products. In the case of imported taxable products to 
which an election under this paragraph (c)(2) applies--
    (A) Tax is imposed on the products on the date of entry (as 
determined under paragraph (c)(2)(ii) of this section) if the products 
are entered into the United States after the election becomes effective;
    (B) Tax is imposed on the products on the date the election becomes 
effective if the products were entered into the United States after 
December 3l, 1989, and before the election becomes effective; and
    (C) No tax is imposed if the products were entered into the United 
States before January 1, 1990.
    (ii) Date of entry. The date of entry is determined by reference to 
customs law. If the actual date is unknown, the importer may use any 
reasonable and consistent method to determine the date of entry, 
provided that such date is within 10 business days of arrival of 
products in the United States.
    (iii) Applicability of election. An election under this paragraph 
(c)(2) applies to all imported taxable products that are owned (and have 
not been used) by the importer at the time the election becomes 
effective and all imported taxable products that are entered into the 
United States by the importer after the election becomes effective. An 
election under this paragraph (c)(2) becomes effective at the beginning 
of the first calendar quarter to which the election applies. After 
October 9, 1990, the election may be revoked only with the consent of 
the Commissioner.
    (iv) Making the election. An election under this paragraph (c)(2) 
shall be made in accordance with the instructions for the return on 
which the importer is required to report liability for tax under section 
4681.
    (3) Treating the sale of an article incorporating an imported 
taxable product as the first sale or use of such product--(i) In 
general. In the case of articles to be sold, an importer may treat the 
sale of an article manufactured or assembled in the United States as the 
first sale or use of an imported taxable product incorporated in such 
article, but only if the importer--
    (A) Has consistently treated the sale of similar articles as the 
first sale or use of similar imported taxable products; and
    (B) Has not made an election under paragraph (c)(2) of this section.
    (ii) Similar articles and imported taxable products. An importer may 
establish any reasonable criteria for determining whether articles or 
imported taxable products are similar for purposes of this paragraph 
(c)(3).
    (iii) Establishment of consistent treatment. An importer has 
consistently treated the sale of similar articles as the first sale or 
use of similar imported taxable products only if such treatment is 
reflected in the computation of tax on the importer's returns for all 
prior calendar quarters in which such treatment would affect tax 
liability.
    (iv) Example. The application of this paragraph (c)(3) may be 
illustrated by the following example:

    Example. (a) An importer of printed circuits and other electronic 
components uses those products in assembling television receivers in the 
United States and also uses the printed circuits in assembling VCRs in 
the United States. Under the importer's criteria for determining 
similarity, printed circuits are similar to other printed circuits, but 
not to the other electronic components. In addition, television 
receivers are similar to other television receivers, but not to VCRs. 
The importer has not made an election under paragraph (c)(2) of this 
section.
    (b) Under this paragraph (c)(3), the importer may treat the sale of 
the television receivers as the first sale or use of the imported 
printed circuits incorporated into the television receivers. In that 
case, the tax on the printed circuits would be imposed when the 
television receivers are sold rather than

[[Page 32]]

when the printed circuits are used in assembling the television 
receivers.
    (c) The importer may treat the sale of the television receivers as 
the first sale or use of the printed circuits incorporated into the 
television receivers even if the sale of the television receivers is not 
treated as the first sale or use of the other electronic components 
incorporated into the television receivers and even if the sale of VCRs 
is not treated as the first sale or use of the printed circuits 
incorporated into the VCRs. Under paragraph (c)(3)(i)(A) of this 
section, however, the importer must have consistently treated the sale 
of television receivers as the first sale or use of printed circuits 
incorporated into the receivers. Thus, in the case of television 
receivers that were assembled before January 1, 1990, and sold after 
December 31, 1989, the importer must have treated the sale of the 
television receivers as the first sale or use of the printed circuits 
incorporated into the television receivers when reporting tax under 
section 4681 with respect to such printed circuits.

    (d) ODCs used as materials in the manufacture of imported taxable 
products--(1) ODC weight. The tax imposed on an imported taxable product 
under section 4681 is computed by reference to the weight of the ODCs 
used as materials in the manufacture of the product (ODC weight). The 
ODC weight of a product includes the weight of ODCs used as materials in 
the manufacture of any components of the product.
    (2) ODCs used as materials in the manufacture of a product. Except 
as provided in paragraph (d)(3) of this section, an ODC is used as a 
material in the manufacture of a product if the ODC is--
    (i) Incorporated into the product;
    (ii) Released into the atmosphere in the process of manufacturing 
the product; or
    (iii) Otherwise used in the manufacture of the product (but only to 
the extent the cost of the ODC is properly allocable to the product).
    (3) Protective packaging. ODCs used in the manufacture of the 
protective material in which a product is packaged are not treated as 
ODCs used as materials in the manufacture of such product.
    (4) Examples. The provisions of this paragraph (d) may be 
illustrated by the following examples:

    Example 1. A, a manufacturer located outside the United States, uses 
ODCs as a solvent to clean the printed circuits it manufactures and as a 
coolant in the air-conditioning system of the factory in which the 
printed circuits are manufactured. The ODCs used as a solvent are 
released into the atmosphere, and, under paragraph (d)(2)(ii) of this 
section, are used as materials in the manufacture of the printed 
circuits. The ODCs used as a coolant in the air-conditioning system are 
also used in the manufacture of the printed circuits. Under paragraph 
(d)(2)(iii) of this section, these ODCs are used as materials in the 
manufacture of the printed circuits only to the extent the cost of the 
ODCs is properly allocable to the printed circuits.
    Example 2. B manufactures television receivers outside the United 
States and wraps them for shipping in a protective packing material 
manufactured with ODCs. Under paragraph (d)(3) of this section, the ODCs 
used in the manufacture of the protective packing material are not 
treated as ODCs used as a material in the manufacture of the television 
receivers.

    (e) Methods of determining ODC weight; computation of tax--(1) In 
general. This paragraph (e) sets forth the methods to be used for 
determining the ODC weight of an imported taxable product and a method 
to be used in computing the tax when the ODC weight cannot be 
determined. The amount of tax is computed separately for each imported 
taxable product and the method to be used in determining the ODC weight 
or otherwise computing the tax is separately determined for each such 
product. Thus, an importer may use one method in computing the tax on 
some imported taxable products and different methods in computing the 
tax on other products. For example, an importer of telephone sets may 
compute the tax using the exact method described in paragraph (e)(2) of 
this section for determining the ODC weight of telephone sets supplied 
by one manufacturer and using the Table method described in paragraph 
(e)(3) of this section for telephone sets supplied by other 
manufacturers that have not provided sufficient information to allow the 
importer to use the exact method.
    (2) Exact method. If the importer determines the weight of each ODC 
used as a material in the manufacture of an imported taxable product and 
supports that determination with sufficient and reliable information, 
the ODC weight of the product is the weight so determined. Under this 
method, the ODC

[[Page 33]]

weight of a mixture is equal to the weight of the ODCs contained in the 
mixture. Representations by the manufacturer of the product to the 
importer as to the weight of the ODCs used as materials in the 
manufacture of the product may be sufficient and reliable information 
for this purpose. Thus, a letter to the importer signed by the 
manufacturer may constitute sufficient and reliable information if the 
letter adequately identifies the product and states the weight of each 
ODC used as a material in the product's manufacture.
    (3) Table method--(i) In general. If the ODC weight of an imported 
taxable product is not determined using the exact method described in 
paragraph (e)(2) of this section and the current Table specifies an ODC 
weight for the product, the ODC weight of the product is the Table ODC 
weight, regardless of what ODCs were used in the manufacture of the 
product. In computing the amount of tax, the Table ODC weight shall not 
be rounded.
    (ii) Special rules--(A) Articles assembled in the United States. An 
importer that assembles finished articles in the United States may 
compute the amount of tax imposed on the imported taxable products 
incorporated into the finished article by using the Table ODC weight 
specified for the article instead of the Table ODC weights specified for 
the components. In order to compute the tax under this special rule, the 
importer must determine the actual number of articles manufactured. For 
example, if an importer manufactures 100 camcorders using imported 
subassemblies, the importer may compute the amount of tax on the 
subassemblies by using the Table ODC weight specified for camcorders. 
Thus, the tax imposed on the subassemblies is equal to the tax that 
would be imposed on 100 camcorders.
    (B) Combination method. This paragraph (e)(3)(ii)(B) applies to an 
imported taxable product if the current Table specifies weights for two 
or more ODCs with respect to the product and the importer of the product 
can determine the weight of any such ODC (and of any ODC used as a 
substitute for such ODC) and can support such determination with 
sufficient and reliable information. In determining the ODC weight of 
any such product, the importer may replace the weight specified in the 
Table for such ODC with the weight (as determined by the importer) of 
such ODC and its substitutes. For example, if an importer has sufficient 
and reliable information to determine the amount of CFC-12 included in a 
product as a coolant (and to determine that no ODCs have been used as 
substitutes for CFC-12) but cannot determine the amount of CFC-113 used 
in manufacturing the product's electronic components, the importer may 
use the weight specified in the Table for CFC-113 and the actual weight 
determined by the importer for CFC-12 in determining the ODC weight of 
the product.
    (C) ODCs used in the manufacture of rigid foam insulation. In 
computing the tax using the method described in this paragraph (e)(3), 
any ODC for which the Table specifies a weight followed by an asterisk 
(*) shall be treated as an ODC used in the manufacture of rigid foam 
insulation (as defined in Sec. 52.4682-1(d) (3) and (4)).
    (4) Value method--(i) General rule. If the importer cannot determine 
the ODC weight of an imported taxable product under the exact method 
described in paragraph (e)(2) of this section and the Table ODC weight 
of the product is not specified, the tax imposed on the product under 
section 4681 is one percent of the entry value of the product.
    (ii) Special rule for mixtures. If, in the case of an imported 
taxable product that is a mixture, the tax was determined under the 
method described in this paragraph (e)(4), the Commissioner may 
redetermine the tax based on the ODC weight of the mixture.
    (5) Adjustment for prior taxes--(i) In general. If any manufacture 
with respect to an imported taxable product occurred in the United 
States or the product incorporates a taxed component or a taxed chemical 
was used in its manufacture, the product's ODC weight (or value) 
attributable to manufacture within the United States or to taxed 
components or taxed chemicals shall be disregarded in computing the tax 
on such product using a method described in paragraph (e) (2), (3), or 
(4) of this section.

[[Page 34]]

    (ii) Taxed component. The term ``taxed component'' means any 
component that previously was subject to tax as an imported taxable 
product or that would have been so taxed if section 4681 had been in 
effect for periods before January 1, 1990.
    (iii) Taxed chemical. The term ``taxed chemical'' means any ODC that 
previously was subject to tax.
    (6) Examples. The application of this paragraph (e) may be 
illustrated by the following examples:

    Example 1. A is an importer (as defined in Sec. 52.4681-1(c)(5)) of 
VCRs. The HTS classification for the VCRs is 8528.10.40. VCRs classified 
under HTS heading 8528.10.40 are imported taxable products because they 
are listed in the Table (contained in paragraph (f)(6) of this section) 
by name and HTS heading (as described in paragraph (f)(3)(i) of this 
section). Each VCR is wrapped in protective packing material 
manufactured with ODCs. A imports and sells 100 VCRs during the first 
calendar quarter of 1991. A may determine the ODC weight for the VCRs by 
reference to the Table. The Table ODC weight specified for VCRs 
classified under HTS heading 8528.10.40 is 0.0586 pound of CFC-113. This 
weight does not take protective packaging into account. The amount of 
tax for the first quarter of 1991 is $6.42 (0.0586 (the ODC weight) x 
100 (the number of VCRs sold in the quarter) x $1.37 (the base tax 
amount for CFC-113 in 1991) x 0.8 (the ozone-depletion factor for CFC-
113)). If A uses the exact method (as described in paragraph (e)(2) of 
this section) to determine the ODC weight for the VCRs, A does not take 
into account the ODCs used in the manufacture of the protective 
packaging. (Imported protective packaging containing foams made with 
ODCs other than foams defined in Sec. 52.4682-1(d)(3) is subject to 
tax, however, if the packaging is sold as packaging or first used as 
packaging in the United States.)
    Example 2. The facts are the same as in Example 1, except that A's 
VCRs are manufactured using methyl chloroform as the solvent instead of 
CFC-113. If A does not use the exact method to determine the weight of 
the methyl chloroform used in the manufacture of the VCRs, A must, under 
paragraphs (e)(3)(i) and (e)(4)(i) of this section, determine the ODC 
weight by reference to the Table. If A uses the Table ODC weight, the 
computation of tax is the same as in Example 1, using the base tax 
amount and ozone-depletion factor for CFC-113. A does not substitute the 
base tax amount and ozone-depletion factor of methyl chloroform for 
those of CFC-113.
    Example 3. B imports and sells mixtures of ethylene oxide and CFC-
12. The mixture is 88 percent CFC-12 by weight. B also imports and sells 
R-502. The R-502 is 51 percent CFC-115 by weight. In the first calendar 
quarter of 1991 B sells 100 pounds of imported ethylene oxide/CFC-12 
mixture and 10,000 pounds of imported R-502. The ethylene/CFC-12 mixture 
and the R-502 are imported taxable products because they are listed in 
Part I of the Table (contained in paragraph (f)(6) of this section). 
Under the exact method described in paragraph (e)(2) of this section, B 
computes the tax based on 88 pounds of CFC-12, the amount of ODCs 
contained in the imported ethylene oxide mixture, and based on 5100 
pounds of CFC-115, the amount of ODCs in the imported R-502.

    (f) Imported Products Table--(1) In general. This paragraph (f) 
contains rules relating to the Imported Products Table (Table) and sets 
forth the Table. The Table lists all the products that are subject to 
the tax on imported taxable products and specifies the Table ODC weight 
of each product for which such a weight has been determined.
    (2) Applicability of Table--(i) In general. Except as provided in 
paragraph (f)(2)(ii) of this section, the Table contained in paragraph 
(f)(6) of this section is effective on January 1, 1990.
    (ii) Treatment of certain products--(A) Products included in a 
listing that is preceded by a double asterisk (**) in the Table shall 
not be treated as imported taxable products until October 1, 1990.
    (B) Products included in a listing that is preceded by a triple 
asterisk (***) in the Table shall not be treated as imported taxable 
products until January l, 1992.
    (3) Identification of products--(i) In general. Each listing in the 
Table identifies a product by name and includes only products that are 
described by that name. Most listings (other than listings for mixtures) 
identify a product by both name and HTS heading. In such cases, a 
product is included in that listing only if the product is described by 
that name and the rate of duty on the product is determined by reference 
to that HTS heading. However, the product is included in that listing 
even if it is manufactured with or contains a different ODC than the ODC 
specified in the Table.
    (ii) Electronic items not listed by specific name--(A) In general. 
Part II of the Table contains listings for electronic items that are not 
included within any

[[Page 35]]

other listing in the Table. An imported product is included in these 
listings only if such imported product--
    (1) Is an electronic component listed in chapters 84, 85, or 90 of 
the Harmonized Tariff Schedule; or
    (2) Contains components described in paragraph (f)(3)(ii)(A)(1) of 
this section and more than 15 percent of the cost of the imported 
product is attributable to such components.
    (B) Electronic component. For purposes of this paragraph (f)(3)(ii), 
an electronic component is a component whose operation involves the use 
of nonmechanical amplification or switching devices such as tubes, 
transistors, and integrated circuits. Such components do not include 
passive electrical devices such as resistors and capacitors.
    (C) Certain items not included. Items such as screws, nuts, bolts, 
plastic parts, and similar specially fabricated parts that may be used 
to construct an electronic item are not themselves included in the 
listing for electronic items not otherwise listed in the Table.
    (iii) Examples. The application of this paragraph (f)(3) may be 
illustrated by the following examples:

    Example 1. The Table lists ``electronic integrated circuits and 
microassemblies; HTS heading 8542.'' A bipolar transistor under HTS 
heading 8542.11.00.05 is included in this listing because a bipolar 
transistor is a type of electronic integrated circuit and HTS heading 
8542.11.00.05 is included within HTS heading 8542.
    Example 2. The Table lists ``radios; HTS heading 8527.19,'' ``radio 
combinations; HTS heading 8527.11'' and ``radio combinations; HTS 
heading 8527.31.'' A radio classified under HTS heading 8527.19 is not 
included within either listing for radio combinations. However, a radio 
classified under HTS heading 8527.19.00.20 is included within the 
listing for radios; HTS heading 8527.19. A radio combination classified 
under HTS heading 8527.11.20 is included within the listing for radio 
combinations; HTS heading 8527.11 but not the listing for radio 
combinations; HTS heading 8527.31. Any radio or radio combination not 
classified under the HTS heading for any other listing is included in 
the listing for electronic items not otherwise listed.

    (4) Rules for listing products. Products are listed in the Table in 
accordance with the following rules:
    (i) Listing in part I. A product is listed in part I of the Table if 
it is a mixture containing ODCs. In addition, a product other than a 
mixture containing ODCs will be listed in part I of a revised Table if 
the Commissioner has determined that--
    (A) The ODC weight of the product is not de minimis when the product 
is produced using the predominant method of manufacturing the product; 
and
    (B) None of the ODCs used as materials in the manufacture of the 
product under the predominant method are used for purposes of 
refrigeration or air conditioning, creating an aerosol or foam, or 
manufacturing electronic components.
    (ii) Listing in part II. A product is listed in part II of the Table 
if the Commissioner has determined that the ODCs used as materials in 
the manufacture of the product under the predominant method are used for 
purposes of refrigeration or air conditioning, creating an aerosol or 
foam, or manufacturing electronic components.
    (iii) Listing in part III. A product is listed in part III of the 
Table if the Commissioner has determined that the product is not an 
imported taxable product and the product would otherwise be included 
within a listing in part II of the Table. For example, floppy disk drive 
units are listed in part III because they are not imported taxable 
products and they would, but for their listing in part III, be included 
within the part II listing for electronic items not specifically 
identified.
    (5) Table ODC weight. The Table ODC weight of a product is the 
weight, determined by the Commissioner, of the ODCs that are used as 
materials in the manufacture of the product under the predominant method 
of manufacturing. The Table ODC weight is given in pounds per single 
unit of product unless otherwise specified.
    (6) Table. The Table is set forth below:

[[Page 36]]



                                             Imported Products Table
----------------------------------------------------------------------------------------------------------------
                                                                    Harmonized
                                                                      tariff
                          Product name                               schedule           ODC         ODC weight
                                                                      heading
----------------------------------------------------------------------------------------------------------------
Part I--Products that are mixtures containing ODCs:
Mixtures containing ODCs, including but not limited to:
    --anti-static sprays........................................
    --automotive products such as ``carburetor cleaner,'' ``stop
     leak,'' and ``oil charge''.................................
    --cleaning solvents.........................................
    --contact cleaners..........................................
    --degreasers................................................
    --dusting sprays............................................
    --electronic circuit board coolants.........................
    --electronic solvents.......................................
    --ethylene oxide/CFC-12.....................................
    --fire extinguisher preparations and charges................
    --flux removers for electronics.............................
    --insect and wasp sprays....................................
    --mixtures of ODCs..........................................
    --propellants...............................................
    --refrigerants..............................................  ..............  ..............  ..............
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                           Harmonized
                                             tariff
              Product name                  schedule                ODC                      ODC weight
                                             heading
----------------------------------------------------------------------------------------------------------------
Part II--Products in which ODCs are
 used for purposes of refrigeration or
 air conditioning, creating an aerosol
 or form or manufacturing electronic
 components:
    Rigid foam insulation defined in     ..............  .........................  ............................
     Sec. 52.4682-1(d)(3).
    Foams made with ODCs, other than     ..............  .........................  ............................
     foams defined in Sec. 52.4682-
     1(d)(3).
    Scrap flexible foams made with ODCs  ..............  .........................  ............................
    Medical products containing ODCs:
        Surgical staplers..............  ..............  .........................  ............................
        Cryogenic medical instruments..  ..............  .........................  ............................
        Drug delivery systems..........  ..............  .........................  ............................
        Inhalants......................  ..............  .........................  ............................
    Dehumidifiers, household...........   8415.82.00.50  CFC-12...................  0.344
    Chillers:..........................   8415.82.00.65  .........................  ............................
        Charged with CFC-12............  ..............  CFC-12...................  1600.
        Charged with CFC-114...........  ..............  CFC-114..................  1250.
        Charged with R-500.............  ..............  CFC-12...................  1920.
    Refrigerator-freezers, household:
        Not  184 liters.....   8418.10.00.10  CFC-11...................  \1\1.08
                                                         CFC-12...................  0.13
         184 liters but not    8418.10.00.20  CFC-11...................  \1\1.32
          269 liters.                         CFC-12...................  0.26
         269 liters but not    8418.10.00.30  CFC-11...................  \1\1.54
          382 liters.                         CFC-12...................  0.35
         382 liters.........   8418.10.00.40  CFC-11...................  \1\1.87
                                                         CFC-12...................  0.35
    Refrigerators, household:
        Not  184 liters.....   8418.21.00.10  CFC-11...................  \1\1.08
                                                         CFC-12...................  0.13
         184 liters but not    8418.21.00.20  CFC-11...................  \1\1.32
          269 liters.                         CFC-12...................  0.26
         269 liters but not    8418.21.00.30  CFC-11...................  \1\1.54
          382 liters.                         CFC-12...................  0.35
         382 liters.........   8418.21.00.90  CFC-11...................  \1\1.87
                                                         CFC-12...................  0.35
    Freezers, household................         8418.30  CFC-11...................  \1\ 2.0
                                                         CFC-12...................  0.4
    Freezers, household................         8418.40  CFC-11...................  \1\2.0
                                                         CFC-12...................  0.4
    Refrigerating display counters not          8418.50  CFC-11...................  \1\ 50.0
      227 kg.                                 CFC-12...................  260.0
    Icemaking machines.................         8418.69  .........................  ............................
        Charged with CFC-12............  ..............  CFC-12...................  1.4
        Charged with R-502.............  ..............  CFC-115..................  3.39
    Drinking water coolers.............         8418.69  .........................  ............................
        Charged with CFC-12............  ..............  CFC-12...................  0.21
        Charged with R-500.............  ..............  CFC-12...................  0.22

[[Page 37]]

 
    Centrifugal chillers, hermetic.....         8418.69  .........................  ............................
        Charged with CFC-12............  ..............  CFC-12...................  1600.
        Charged with CFC-114...........  ..............  CFC-114..................  1250.
        Charged with R-500.............  ..............  CFC-12...................  1920.
    Reciprocating chillers.............         8418.69  .........................  ............................
        Charged with CFC-12............  ..............  CFC-12...................  200.
    Mobile refrigeration systems.......         8418.99  .........................  ............................
        Containers.....................  ..............  CFC-12...................  15.
        Trucks.........................  ..............  CFC-12...................  11.
        Trailers.......................  ..............  CFC-12...................  20.
    Refrigeration condensing units:
        not  746W...........   8418.99.00.05  CFC-12...................  0.3
         746W but not  2.2KW.
         2.2KW but not  7.5KW.
         7.5KW but not  22.3KW.
         22.3 KW............   8418.99.00.25  CFC-12...................  17.0
    Fire extinguishers, charged w/ODCs.            8424  .........................  ............................
    Electronic typewriters and word                8469  CFC-113..................  0.2049
     processors.
    Electronic calculators.............         8470.10  CFC-113..................  0.0035
    Electronic calculators w/printing           8470.21  CFC-113..................  0.0057
     device.
    Electronic calculators.............         8470.29  CFC-113..................  0.0035
    Account machines...................         8470.40  CFC-113..................  0.1913
    Cash registers.....................         8470.50  CFC-113..................  0.1913
    Digital automatic data processing           8471.20  CFC-113..................  0.3663
     machines w/cathode ray tube, not
     included in subheading
     8471.20.00.90.
    Laptops, notebooks, and pocket        8471.20.00.90  CFC-113..................  0.03567
     computers.
    Digital processing units w/entry
     value:
        Not  $100K..........         8471.91  CFC-113..................  0.4980
         $100K..............         8471.91  CFC-113..................  27.6667
    Combined input/output units                 8471.92  CFC-113..................  0.3600
     (terminals).
    Keyboards..........................         8471.92  CFC-113..................  0.0742
    Display units......................         8471.92  CFC-113..................  0.0386
    Printer units......................         8471.92  CFC-113..................  0.1558
    lnput or output units..............         8471.92  CFC-113..................  0.1370
    Hard magnetic disk drive units not
     included in subheading 8471.93.10
     for a disk of a diameter:
        Not  9 cm (3\1/2\            8471.93  CFC-113..................  0.2829
         inches).
         9 cm (3\1/2\                8471.93  CFC-113..................  1.1671
         inches) but not  21
         cm (8\1/4\ inches).
    Nonmagnetic storage units w/ entry          8471.93  CFC-113..................  2.7758
     value  $1,000.
    Magnetic disk drive units for a          8471.93.10  CFC-113..................  4.0067
     disk of a diameter over 21 cm (8\1/
     4\ inches).
    Power supplies.....................      8471.99.30  CFC-113..................  0.0655
    Electronic office machines.........            8472  CFC-113..................  0.001
    Populated cards for digital
     processing units in subheading
     8471.91 w/value:
        Not  $100K..........         8473.30  CFC-113..................  0.1408
         $100K..............         8473.30  CFC-113..................  4.82
    Automatic goods-vending machines            8476.11  CFC-12...................  0.45
     with refrigerating device.
    Microwave ovens with electronic             8516.50  .........................  ............................
     controls, with capacity of.
        0.99 cu. ft. or less...........  ..............  CFC-113..................  0.0300
        1.0 through 1.3 cu. ft.........  ..............  CFC-113..................  0.0441
        1.31 cu. ft. or greater........  ..............  CFC-113..................  0.0485
    Microwave oven combinations with      8516.60.40.60  CFC-113..................  0.0595
     electronic controls.
    Telephone sets w/entry value:
        Not  $11.00.........         8517.10  CFC-113..................  0.0225
         $11.00.............         8517.10  CFC-113..................  0.1
    Teleprinters and teletypewriters...         8517.20  CFC-113..................  0.1
    Switching equipment not included in         8517.30  CFC-113..................  0.1267
     subheading 8517.30.20.
    Private branch exchange switching        8517.30.20  CFC-113..................  0.0753
     equipment.
    Modems.............................         8517.40  CFC-113..................  0.0225
    Intercoms..........................         8517.81  CFC-113..................  0.0225
    Facsimile machines.................         85l7.82  CFC-113..................  0.0225
    Loudspeakers, microphones,                     8518  CFC-113..................  0.0022
     headphones, and electric sound
     amplifier sets, not included in
     subheading 8518.30.10.
    Telephone handsets.................      8518.30.10  CFC-113..................  0.042
    Turntables, record players,                    8519  CFC-113..................  0.0022
     cassette players, and other sound
     reproducing apparatus.
    Magnetic tape recorders and other              8520  CFC-113..................  0.0022
     sound recording apparatus, not
     included in subheading 8520.20.
    Telephone answering machines.......         8520.20  CFC-113..................  0.1
    Color video recording/reproducing     8521.10.00.20  CFC-113..................  0.0586
     apparatus.
    Videodisc players..................         8521.90  CFC-113..................  0.0106

[[Page 38]]

 
    Cordless handset telephones........      8525.20.50  CFC-113..................  0.1
    Cellular communication equipment...      8525.20.60  CFC-113..................  0.4446
    TV cameras.........................         8525.30  CFC-113..................  1.423
    Camcorders.........................         8525.30  CFC-113..................  0.0586
    Radio combinations.................         8527.11  CFC-113..................  0.0022
    Radios.............................         8527.19  CFC-113..................  0.0014
    Motor Vehicle radios with or w/o            8527.21  CFC-113..................  0.0021
     tape player.
    Radio combinations.................         8527.31  CFC-113..................  0.0022
    Radios.............................         8527.32  CFC-113..................  0.0014
    Tuners w/o speaker.................   8527.39.00.20  CFC-113..................  0.0022
    Television receivers...............            8528  CFC-113..................  0.0386
    VCRs...............................      8528.10.40  CFC-113..................  0.0586
    Home satellite earth stations......   8528.10.80.55  CFC-113..................  0.0106
    Electronic assemblies for HTS               8529.90  CFC-113..................  0.0816
     headings 8525, 8527, & 8528.
    Indicator panels incorporating              8531.20  CFC-113..................  0.0146
     liquid crystal devices or light
     emitting diodes.
    Printed circuits...................            8534  CFC-113..................  0.001
    Computerized numerical controls....   8537.10.00.30  CFC-113..................  0.1306
    Diodes, crystals, transistors and              8541  CFC-113..................  0.0001
     other similar discrete
     semiconductor devices.
    Electronic integrated circuits and             8542  CFC-113..................  0.0002
     microassemblies.
    Signal generators..................         8543.20  CFC-113..................  0.6518
    Avionics...........................      8543.90.40  CFC-113..................  0.915
    Signal generators subassemblies....      8543.90.80  CFC-113..................  0.1265
    Insulated or refrigerated railway              8606  CFC-11...................  \1\100.
     freight cars.
    Passenger automobiles..............            8703  .........................  ............................
        Foams (interior)...............  ..............  CFC-11...................  0.8
        Foams (exterior)...............  ..............  CFC-11...................  0.7
        With charged a/c...............  ..............  CFC-12...................  2.0
        Without charged a/c............  ..............  CFC-12...................  0.2
        Electronics....................  ..............  CFC-113..................  0.5
    Light trucks.......................            8704  .........................  ............................
        Foams (interior)...............  ..............  CFC-11...................  0.6
        Foams (exterior)...............  ..............  CFC-11...................  0.1
        With charged a/c...............  ..............  CFC-12...................  2.0
        Without charged a/c............  ..............  CFC-12...................  0.2
        Electronics....................  ..............  CFC-113..................  0.4
    Heavy trucks and tractors, GVW                 8704  .........................  ............................
     33,001 lbs or more: \2\.
        Foams (interior)...............  ..............  CFC-11...................  0.6
        Foams (exterior)...............  ..............  CFC-11...................  0.1
        With charged a/c...............  ..............  CFC-12...................  3.0
        Without charged a/c............  ..............  CFC-12...................  0.2
        Electronics....................  ..............  CFC-113..................  0.4
    Motorcycles with seat foamed with              8711  CFC-11...................  0.04
     ODCs.
    Bicycles with seat foamed with ODCs            8712  CFC-11...................  0.04
    Seats foamed with ODCs.............         8714.95  CFC-11...................  0.04
    Aircraft...........................            8802  CFC-12...................  0.25 lb/1000 lbs Operating
                                                                                     Empty Weight (OEW).
                                         ..............  CFC-113..................  30.0 lbs./1000 lbs.OEW
    Optical fibers.....................            9001  CFC-12...................  0.005 lb/thousand feet.
    Electronic cameras.................            9006  CFC-113..................  0.01
    Photocopiers.......................            9009  CFC-113..................  0.0426
    Avionics...........................         9014.20  CFC-113..................  0.915
    Electronic drafting machines.......            9017  CFC-113..................  0.12
    Complete patient monitoring systems      9018.19.80  CFC-12...................  0.94
                                                         CFC-113..................  3.4163
    Complete patient monitoring           9018.19.80.60  CFC-113..................  1.9320
     systems; subassemblies thereof.
    Physical or chemical analysis                  9027  CFC-12...................  0.0003
     instruments.                                        CFC-113..................  0.0271
    Oscilloscopes......................            9030  CFC-11...................  0.49
                                                         CFC-12...................  0.5943
                                                         CFC-113..................  0.2613
    Foam chairs........................            9401  CFC-11...................  0.30
    Foam sofas.........................            9401  CFC-11...................  0.75
    Foam mattresses....................         9404.21  CFC-11...................  1.60
    Electronic games and electronic                9504  CFC-113..................  ............................
     components thereof.
Electronic items not otherwise listed
 in the Table:
    Included in HTS chapters 84, 85, 90  ..............  CFC-113..................  0.0004 pound/$1.00 of entry
                                                                                     value.

[[Page 39]]

 
    Not included in HTS chapters 84,     ..............  CFC-113..................  0.0004 pound/$1.00 of entry
     85, 90 \3\.                                                                     value.
 
PART III--Products that are not
 Imported Taxable Products:
    Room air conditioners..............   8415.10.00.60  .........................  ............................
    Dishwashers........................         8422.11  .........................  ............................
    Clothes washers....................         8450.11  .........................  ............................
    Clothes dryers.....................         8451.21  .........................  ............................
    Floppy disk drive units............         8471.93  .........................  ............................
    Transformers and inductors.........            8504  .........................  ............................
    Toasters...........................         8516.72  .........................  ............................
    Unrecorded media...................            8523  .........................  ............................
    Recorded media.....................            8524  .........................  ............................
    Capacitors.........................            8532  .........................  ............................
    Resistors..........................            8533  .........................  ............................
    Switching apparatus................            8536  .........................  ............................
    Cathode tubes......................            8540  .........................  ............................
----------------------------------------------------------------------------------------------------------------
\1\ See paragraph (e)(3)(ii)(C) of this section. Denotes an ODC used in the manufacture of rigid foam
  insulation.
\2\ See paragraph (f)(2)(ii)(A) of this section. Denotes product for which the effective date is October 1,
  1990.
\3\ See paragraph (f)(2)(ii)(B) of this section. Denotes products for which the effective date is January 1,
  1992.

    (g) Requests for modification of Table--(1) In general. Any 
manufacturer or importer of a product may request that the Secretary 
modify the Table in any of the following respects:
    (i) Adding a product to the Table and specifying its Table ODC 
weight.
    (ii) Removing a product from the Table.
    (iii) Changing or specifying the Table ODC weight of a product.
    (2) Form of request. The Secretary will consider a request for 
modification that includes the following:
    (i) The name, address, taxpayer identifying number, and principal 
place of business of the requester.
    (ii) For each product with respect to which a modification is 
requested:
    (A) The name of the product;
    (B) The HTS heading or subheading;
    (C) The type of modification requested;
    (D) The Table ODC weight that should be specified for the product if 
the request relates to adding a product or changing or specifying its 
Table ODC weight; and
    (E) The data supporting the request.
    (3) Address. The address for submission of requests under this 
paragraph (g) is: Internal Revenue Service, P.O. Box 7604, Ben Franklin 
Station, Attn: CC:CORP:T:R (Imported Products Table), room 5228, 
Washington, DC 20044.
    (4) Public inspection and copying. Requests submitted under this 
paragraph (g) will be available in the Internal Revenue Service Freedom 
of Information Reading Room for public inspection and copying.

[T.D. 8370, 56 FR 56311, Nov. 4, 1991, as amended by T.D. 8370, 58 FR 
14518, Mar. 18, 1993]



Sec. 52.4682-4  Floor stocks tax.

    (a) Overview. This section provides rules for identifying ozone-
depleting chemicals (ODCs) that are subject to the floor stocks tax 
imposed by section 4682(h)(1), determining the person that is liable for 
the tax, and computing the amount of the tax. See Sec. 52.4681-1(a)(3) 
and (c) for general rules and definitions relating to the floor stocks 
tax.
    (b) Identifying rules--(1) ODCs subject to floor stocks tax; ODCs 
held for sale or for use in further manufacture--(i) In general. The 
floor stocks tax is imposed only on an ODC that is held for sale or for 
use in further manufacture on the date the tax is imposed. This 
paragraph (b)(1) provides rules for identifying ODCs held for sale or 
for use in further manufacture.
    (ii) Held for sale--(A) In general. For purposes of determining 
whether an ODC is held for sale, the term sale shall have the meaning 
set forth in Sec. 52.4681-1(c)(6). ODCs held for sale include ODCs that 
will be sold in connection with the provision of services or in 
connection with the sale of a manufactured article and, in such cases, 
include ODCs that will be sold without the statement of a separate 
charge for those ODCs.

[[Page 40]]

    (B) ODCs held by a government. An ODC that is held by a government 
for its own use is not held for sale even if the ODC will be transferred 
between agencies or other subdivisions that have or are required to have 
different employer identification numbers.
    (iii) Held for use in further manufacture. Except as otherwise 
provided in paragraph (b)(2)(v) of this section, an ODC is held for use 
in further manufacture if--
    (A) The ODC will be used as a material (within the meaning of 
paragraph (b)(1)(iv) of this section) in the manufacture of an article; 
and
    (B) Such article will be held for sale.
    (iv) Use as material--(A) In general. Except as provided in 
paragraph (b)(1)(iv)(B) of this section, an ODC will be used as a 
material in the manufacture of an article if the ODC will be--
    (1) Incorporated into the article; or
    (2) Released into the atmosphere in the process of manufacturing the 
article.
    (B) ODCs used in equipment. For purposes of the floor stocks tax, an 
ODC is not used as a material in the manufacture of an article if the 
ODC is (or will be) contained in equipment used in such manufacture and 
the ODC will be used for its intended purpose without being released 
from such equipment. Thus, ODCs that are (or will be) used as coolants 
in a factory's air-conditioning system are not used as materials in the 
manufacture of articles produced in the factory.
    (v) Storage containers. The floor stocks tax is imposed on an ODC 
without regard to the type or size of the storage container in which the 
ODC is held. Thus, the tax may apply to an ODC whether it is in a 14-
ounce can or a 30-pound tank.
    (vi) Examples. The provisions of this paragraph (b)(1) may be 
illustrated by the following examples:

    Example 1. A, a manufacturer of air conditioners, holds an ODC for 
use in air conditioners that it will manufacture and sell. A holds the 
ODC for use in further manufacture.
    Example 2. B, a manufacturer of electronic components, holds an ODC 
for use as a solvent to clean printed circuits that it will sell to 
computer manufacturers. B holds the ODC for use in further manufacture.
    Example 3. C, an automobile dealer, holds an ODC for use in charging 
air conditioners installed in automobiles that it sells to retail 
customers. C does not hold the ODC for use in further manufacture. C 
does, however, hold the ODC for sale, even if the customers are not 
separately charged for ODCs used in the automobile air conditioners.
    Example 4. D operates an air-conditioning repair service and holds 
an ODC for use in repairing air conditioners for its customers. D holds 
the ODC for sale even if the customers are not separately charged for 
ODCs used in the repairs.
    Example 5. E, a grocery-store chain, holds an ODC for use in its 
refrigeration units. E does not hold the ODC for sale or for use in 
further manufacture.
    Example 6. F, a bank, holds an ODC for use in its fire extinguishers 
to protect the computer system. F does not hold the ODC for sale or for 
use in further manufacture.
    Example 7. G, a government agency, holds an ODC for use in the 
refrigeration equipment of its various units. The units have separate 
employer identification numbers. The ODC is stored in a central 
warehouse until needed by a unit and then transferred to the unit upon 
request. G does not hold the ODC for sale or for use in further 
manufacture.

    (2)(i) Mixtures--(A) Tax imposed on January 1, 1990. In the case of 
the floor stocks tax imposed on January l, 1990, the tax is not imposed 
on an ODC that has been mixed with any other ingredients.
    (B) Taxes imposed after 1990--(1) In general. In the case of the 
floor stocks tax imposed on January 1 of a calendar year after 1990, the 
tax is not imposed on an ODC that has been mixed with any other 
ingredients, but only if it is established that such ingredients 
contribute to the accomplishment of the purpose for which the mixture 
will be used. A mixture is not exempt from tax under this paragraph 
(b)(2)(i)(B), however, if it contains only an ODC and an inert 
ingredient that does not contribute to the accomplishment of the purpose 
for which the mixture will be used.
    (2) Exception. In the case of a floor stocks tax imposed on or after 
January 1, 1992, a mixture is not exempt from floor stocks tax under 
this paragraph (b)(2)(i)(B) if it contains only ODCs and one or more 
stabilizers. For this purpose, the term stabilizer means an ingredient 
needed to maintain the chemical integrity of the ODC.

[[Page 41]]

    (C) Examples. The provisions of this paragraph (b)(2)(i) may be 
illustrated by the following examples:

    Example 1. The floor stocks tax is not imposed on the ODCs contained 
in refrigerants such as R-500 and R-502 because such products are 
mixtures of ODCs and other chemicals that contribute to the 
accomplishment of the purpose for which the mixture will be used.
    Example 2. The floor stocks tax is not imposed on the ODCs contained 
in automotive products used for checking for leaks because such products 
are a mixture of ODCs and small amounts of dyes and oils that contribute 
to the accomplishment of the purpose for which the mixture will be used.
    Example 3. The floor stocks tax is not imposed on Halon 1301 
pressurized with nitrogen. Although nitrogen is an inert ingredient, it 
contributes to the accomplishment of the purpose for which the mixture 
will be used.
    Example 4. On January 1, 1993, the floor stocks tax is imposed on 
methyl chloroform that is stabilized to prevent hydrolization or 
chemical reaction during transportation or use, unless the stabilized 
methyl chloroform has also been mixed with other ingredients that 
contribute to the accomplishment of the purpose for which the mixture 
will be used.

    (ii) Manufactured articles. The floor stocks tax is not imposed on 
an ODC that is contained in a manufactured article in which the ODC will 
be used for its intended purpose without being released from such 
article. For example, the tax is not imposed on the ODCs contained in 
the cooling coils of a refrigerator even if the refrigerator is held for 
sale. However, the tax is imposed on a can of ODC used to recharge an 
air conditioning unit because the ODC must be expelled from the can in 
order to be used. Similarly, beginning in 1991, the tax is imposed on 
Halons contained in a fire extinguisher held for sale because such ODCs 
must be expelled from the fire extinguisher in order to be used.
    (iii) Recycled ODCs. The floor stocks tax is not imposed on ODCs 
that have been reclaimed or recycled. For example, the tax is not 
imposed on an ODC that is held for use in further manufacture after 
being used as a solvent and recycled.
    (iv) ODCs held by the manufacturer or importer. The floor stocks tax 
is not imposed on ODCs held by their manufacturer or importer.
    (v) ODCs used as a feedstock--(A) In general. The floor stocks tax 
is not imposed on any ODC that was sold in a qualifying sale for use as 
a feedstock (as defined in Sec. 52.4682-1(c)).
    (B) Post-1989 ODCs sold before January 1, 1990; post-1990 ODCs sold 
before January 1, 1991. A post-1989 ODC that was sold by its 
manufacturer or importer before January 1, 1990, or a post-1990 ODC that 
was sold by its manufacturer or importer before January 1, 1991, shall 
be treated, for purposes of this paragraph (b)(2)(v), as an ODC that was 
sold in a qualifying sale for purposes of Sec. 52.4682-1(c) if the ODC 
will be used as a feedstock (within the meaning of Sec. 52.4682-
2(c)(3)).
    (vi) ODCs to be exported--(A) In general. The floor stocks tax is 
not imposed on any ODC that was sold in a qualifying sale for export (as 
defined in Sec. 52.4682-5(d)(1)).
    (B) ODCs sold before January 1, 1993. An ODC that was sold by its 
manufacturer or importer before January 1, 1993, is treated, for 
purposes of this paragraph (b)(2)(vi), as an ODC that was sold in a 
qualifying sale for export for purposes of Sec. 52.4682-5(d)(1) if the 
ODC will be exported.
    (vii) ODCs used as propellants in metered-dose inhalers; years after 
1992--(A) In general. The floor stocks tax is not imposed on January 1 
of calendar years after 1992 on any ODC that was sold in a qualifying 
sale for use as a propellant in a metered-dose inhaler (as defined in 
Sec. 52.4682-1(h)).
    (B) ODCs sold before January 1, 1993. An ODC that was sold by its 
manufacturer or importer before January 1, 1993, is treated, for 
purposes of this paragraph (b)(2)(vii), as an ODC that was sold in a 
qualifying sale for purposes of Sec. 52.4682-1(h) if the ODC will be 
used as a propellant in a metered-dose inhaler (within the meaning of 
Sec. 52.4682-1(h)).
    (viii) ODCs used as medical sterilants; 1993. The floor stocks tax 
is not imposed in 1993 on any ODC held for use as a medical sterilant 
(as defined in Sec. 52.4682-1(g)).
    (c) Person liable for tax--(1) In general. The person liable for the 
floor stocks tax on an ODC is the person that holds

[[Page 42]]

the ODC on a date on which the tax is imposed. The person who holds the 
ODC is the person who has title to the ODC (whether or not delivery to 
such person has been made) as of the first moment of such date. The 
person who has title at such time is determined under applicable local 
law.
    (2) Special rule. Each business unit that has, or is required to 
have, its own employer identification number is treated as a separate 
person for purposes of the floor stocks tax. For example, a chain of 
automotive parts stores that has one employer identification number is 
one person for purposes of the floor stocks tax, and a parent 
corporation and subsidiary corporation that each have a different 
employer identification number are two persons for purposes of the floor 
stocks tax.
    (d) Computation of tax; tentative tax amount--(1) In general--(i) 
Generally applicable rules. This paragraph (d) provides rules for 
determining the tentative tax amount and the amount of the floor stocks 
tax. Section 52.4681-1(a)(3) provides that the amount of the floor 
stocks tax on an ODC is determined by reference to a tentative tax 
amount. The tentative tax amount is the amount of tax that would be 
imposed on the ODC under section 4681(a)(1) if a sale of the ODC by the 
manufacturer or importer had occurred on the date the floor stocks tax 
is imposed. The amount of the floor stocks tax imposed on the ODCs 
contained in a nonexempt mixture is computed on the basis of the weight 
of the ODCs in that mixture.
    (ii) Floor stocks tax imposed on post-1989 ODCs on January 1, 1990. 
The floor stocks tax imposed on post-1989 ODCs (as defined in Sec. 
52.4681-1(c)(9)) on January 1, 1990, is equal to the tentative tax 
amount. See paragraph (d)(2) of this section for rules relating to the 
floor stocks tax imposed on ODCs used in the manufacture of rigid foam 
insulation. See paragraph (d)(3) of this section for rules relating to 
the floor stocks tax imposed on Halons.
    (iii) Floor stocks tax imposed on post-1990 ODCs on January 1, 1991. 
The floor stocks tax imposed on post-1990 ODCs (as defined in Sec. 
52.4681-1(c)(9)) on January 1, 1991, is equal to the tentative tax 
amount.
    (iv) Other floor stocks taxes--(A) In general. The following rules 
apply for floor stocks taxes imposed on post-1989 ODCs after January 1, 
1990, and on post-1990 ODCs after January 1, 1991:
    (1) The tentative tax amount is determined, except as provided in 
paragraph (d)(2), (3), or (4) of this section, by reference to the rate 
of tax prescribed in section 4681(b)(1)(B) and the ozone-depletion 
factors prescribed in section 4682(b).
    (2) The amount of the floor stocks tax on an ODC is equal to the 
amount by which the tentative tax amount exceeds the amount of taxes 
previously imposed on the ODC.
    (B) Example. The application of this paragraph (d)(1)(iv) may be 
illustrated by the following example:

    Example. The floor stocks tax imposed on one pound of CFC-12 held 
for sale on January 1, 1992, is $0.30 (the amount by which $1.67, the 
tentative tax, exceeds $1.37, the tax previously imposed on CFC-12).

    (2) ODCs used in the manufacture of rigid foam insulation; 1990, 
1991, 1992, and 1993--(i) In general. In the case of an ODC that was 
sold in a qualifying sale for purposes of Sec. 52.4682-1(d) (relating 
to use in the manufacture of rigid foam insulation) the tentative tax 
amount is determined under section 4682(g) for purposes of computing the 
floor stocks tax imposed on the ODC on January 1, 1990, 1991, 1992 or 
1993. For purposes of computing the floor stocks tax imposed on the ODC 
on January 1, 1990, the tentative tax amount is zero. The floor stocks 
tax is not imposed on ODCs for use in the manufacture of rigid foam 
insulation in 1992 and 1993.
    (ii) Post-1989 ODCs sold before January 1, 1990; post-1990 ODCs sold 
before January 1, 1991. A post-1989 ODC that was sold by its 
manufacturer or importer before January 1, 1990, or a post-1990 ODC that 
was sold by its manufacturer or importer before January 1, 1991, shall 
be treated, for purposes of paragraphs (d)(2) and (e) of this section, 
as an ODC that was sold in a qualifying sale for purposes of Sec. 
52.4682-1(d) if the ODC wi11 be used in the manufacture of rigid foam 
insulation (within the meaning of Sec. Sec. 52.4682-1(d) (3) and (4)).
    (3) Halons; 1990, 1991, 1992, and 1993. In the case of Halon-1211, 
Halon-1301, or Halon-2402 (Halons), the tentative tax

[[Page 43]]

amount is determined under section 4682(g) for purposes of computing the 
floor stocks tax imposed on Halons on January 1, 1990, 1991, 1992, or 
1993. For purposes of computing the floor stocks tax imposed on Halons 
on January 1, 1990, the tentative tax amount is zero. The floor stocks 
tax is not imposed on Halons in 1992 and 1993.
    (4) Methyl chloroform; 1993. In the case of methyl chloroform, the 
tentative tax amount is determined under section 4682(g)(5) for purposes 
of computing the floor stocks tax imposed on January 1, 1993.
    (e) De minimis exception--(1) 1990 and 1992. In the case of the 
floor stocks tax imposed on January 1, 1990 or 1992, a person is liable 
for the tax only if, on the date the tax is imposed, the person holds at 
least 400 pounds of post-1989 ODCs that are not described in paragraph 
(d) (2) or (3) of this section and are otherwise subject to tax.
    (2) 1991. In the case of the floor stocks tax imposed on January 1, 
1991, a person is liable for the tax only if, on such date, the person 
holds at least 400 pounds of ODCs subject to the 1991 floor stocks tax. 
For this purpose, ODCs subject to the 1991 floor stocks tax are--
    (i) Post-1990 ODCs that are subject to tax; and
    (ii) Post-1989 ODCs that are described in paragraph (d) (2) or (3) 
of this section and are otherwise subject to tax.
    (3) 1993. In the case of the floor stocks tax imposed on January 1, 
1993, a person is liable for the tax only if, on such date, the person 
holds at least 400 pounds of ODCs that are not described in paragraph 
(d) (2) or (3) of this section and are otherwise subject to tax.
    (4) 1994. In the case of the floor stocks tax imposed on January 1, 
1994, a person is liable for the tax only if, on such date, the person 
holds--
    (i) At least 400 pounds of ODCs that are not described in paragraph 
(d)(2) or (d)(3) of this section and are otherwise subject to tax;
    (ii) At least 200 pounds of ODCs that are described in paragraph 
(d)(2) of this section and are otherwise subject to tax; or
    (iii) At least 20 pounds of ODCs that are described in paragraph 
(d)(3) of this section and are otherwise subject to tax.
    (5) Calendar years after 1994. In the case of the floor stocks tax 
imposed on January 1 of 1995 and each following calendar year, a person 
is liable for the tax only if, on such date, the person holds--
    (i) At least 400 pounds of ODCs that are not described in paragraph 
(d)(3) or (d)(4) of this section and are otherwise subject to tax;
    (ii) At least 50 pounds of ODCs that are described in paragraph 
(d)(3) of this section and are otherwise subject to tax; or
    (iii) At least 1000 pounds of ODCs that are described in paragraph 
(d)(4) of this section and are otherwise subject to tax.
    (6) Examples. The rules of this paragraph (e) may be illustrated by 
the following examples:

    Example 1. On January 1, 1990, A holds for sale 300 pounds of CFC-12 
(a post-1989 ODC not described in paragraph (d)(2) or (d)(3) of this 
section)) and 500 pounds of R-500 (a mixture). A does not hold at least 
400 pounds of ODCs that are taken into account under paragraph (e)(1) of 
this section and, under paragraph (b)(2)(i) of this section, mixtures 
are not subject to the floor stocks tax. Thus, A is not liable for the 
floor stocks tax imposed on January 1, 1990.
    Example 2. On January 1, 1990, B holds for sale 250 pounds of CFC-12 
and 250 pounds of CFC-113 (post-1989 ODCs not described in paragraph (d) 
(2) or (3) of this section). B holds 500 pounds of ODCs that are taken 
into account under paragraph (e)(1) of this section. Thus, B is liable 
for the floor stocks tax imposed on January 1, 1990, because B holds at 
least 400 pounds of ODCs for sale.
    Example 3. On January 1, 1990, C holds 200 pounds of post-1990 ODCs 
and 500 pounds of post-1989 ODCs for use in further manufacture. C will 
use 300 pounds of the post-1989 ODCs in the manufacture of rigid foam 
insulation (as defined in Sec. 52.4682-1(d) (3) and (4)). The remainder 
of the ODCs are not described in paragraph (d) (2) or (3) of this 
section. Under paragraph (e)(1) of this section, post-1990 ODCs and ODCs 
that will be used in the manufacture of rigid foam insulation are 
disregarded in determining whether the de minimis exception is 
applicable in 1990. Thus, C holds only 200 pounds of ODCs that are taken 
into account under paragraph (e)(1) of this section and is not liable 
for the floor stocks tax imposed on January 1, 1990.
    Example 4. (a) The facts are the same as in Example 3, except that 
the ODCs are held on January 1, 1991. Under paragraph (e)(2) of

[[Page 44]]

this section, the 200 pounds of post-1990 ODCs and the 300 pounds of 
post-1989 ODCs that will be used in the manufacture of rigid foam 
insulation are taken into account in determining whether the de minimis 
exception is applicable in 1991. Under paragraph (b)(2) of this section, 
the remaining 200 pounds of post-1989 ODCs are not taken into account 
because the base tax amount applicable to post-1989 ODCs does not 
increase in 1991. Thus, C holds 500 pounds of ODCs that are taken into 
account under paragraph (e)(2) of this section and is liable for the 
floor stocks tax imposed on January 1, 1991.
    (b) The amount of the floor stocks tax imposed on the 200 pounds of 
post-1990 ODCs and the 300 pounds of post-1989 ODCs that will be used in 
the manufacture of rigid foam insulation is equal to the tentative tax 
amount because those ODCs were not previously subject to tax.
    Example 5. (a) On January 1, 1994, D holds for sale 300 pounds of 
CFC-113 (an ODC not described in paragraph (d)(2) or (d)(3) of this 
section) and 25 pounds of Halon-1301 (an ODC described in paragraph 
(d)(3) of this section). D is liable for the floor stocks tax imposed on 
January 1, 1994, because 25 pounds of Halon-1301 exceeds the de minimis 
amount specified in paragraph (e)(4)(iii) of this section. The 300 
pounds of CFC-113 is less than the amount specified in paragraph 
(e)(4)(i) of this section. Nevertheless, tax is imposed on both the 25 
pounds of Halon-1301 and the 300 pounds of CFC-113.
    (b) The amount of the floor stocks tax is determined separately for 
the 300 pounds of CFC-113 and the 25 pounds of Halon-1301 and is equal 
to the difference between the tentative tax amount and the amount of tax 
previously imposed on those ODCs. For Halon-1301, for example, the tax 
is determined as follows. The tentative tax amount is $1,087.50 ($4.35 
(the base tax amount in 1994) x 10 (the ozone-depletion factor for 
Halon-1301) x 25 (the number of pounds held)). The tax previously 
imposed on the Halon-1301 is $6.28 ($3.35 (the base tax amount in 1993) 
x 10 (the ozone-depletion factor for Halon-1301) x 0.75 percent (the 
applicable percentage determined under section 4682(g)(2)(A)) x 25 (the 
number of pounds held)). Thus, the floor stocks tax imposed on the 25 
pounds of Halon-1301 in 1994 is $1,081.22, the difference between 
$1,087.50 (the tentative tax amount) and $6.28 (the tax previously 
imposed).

    (f) Inventory--(1) In general. If, on the date on which the floor 
stocks tax is imposed, a person holds ODCs for sale or for use in 
further manufacture and the ODCs were not manufactured or imported by 
such person, the following rules apply:
    (i) The person shall prepare an inventory of all such ODCs that the 
person holds on the date on which the tax is imposed.
    (ii) The inventory shall be taken as of the first moment of the date 
on which the tax is imposed, but work-back or work-forward inventories 
will be acceptable if supported by adequate commercial records of 
receipt, use, and disposition of ODCs held for sale or for use in 
further manufacture.
    (iii) The person must maintain records of the inventory and make 
such records available for inspection and copying by internal revenue 
agents and officers. Records of the inventory are not to be filed with 
the Internal Revenue Service.
    (2) Circumstances in which an inventory is not required. The 
inventory requirement of paragraph (f)(1) of this section does not apply 
to any person holding, on a date on which floor stocks tax is imposed, 
only ODCs that are not subject to tax by reason of a statutory exemption 
(e.g., use as a feedstock) or regulatory exclusion other than the de 
minimis exception provided by paragraph (e) of this section (e.g., 
mixtures). In addition, any person that holds ODCs subject to the floor 
stocks tax and also holds ODCs that are nontaxable under the provisions 
of paragraph (b)(2) of this section, is not required to inventory the 
nontaxable ODCs. However, any person that holds any ODCs that either are 
subject to the floor stocks tax or would be subject to the floor stocks 
tax but for the de minimis exception must inventory those ODCs.
    (3) Examples. The rules of this paragraph (f) may be illustrated by 
the following examples:

    Example 1. On January 1, 1990, A holds for sale 300 pounds of CFC-12 
(a post-1989 ODC not described in paragraph (d)(2) or (d)(3) of this 
section) and 500 pounds of R-500 (a mixture). As required by paragraph 
(f)(1) of this section, A must prepare an inventory of the CFC-12 A 
holds for sale on that date even though, under paragraph (e)(1) of this 
section, the 300 pounds of CFC-12 is not taken into account because it 
is de minimis. However, as provided in paragraph (f)(2) of this section, 
A is not required to inventory the R-500 because, under paragraph (b)(2) 
of this section, mixtures are not subject to the floor stocks tax.

[[Page 45]]

    Example 2. On January 1, 1991, B holds for sale 1,000 pounds of CFC-
12 (a post-1989 ODC not described in paragraph (d)(2) or (d)(3) of this 
section). As provided under paragraph (f)(2) of this section, B is not 
required to prepare an inventory because CFC-12 is not subject to the 
floor stocks tax in 1991.

    (g) Time for paying tax. The floor stocks tax imposed under section 
4682(h) shall be paid without assessment or notice. In the case of the 
floor stocks tax imposed on January 1, 1990, the tax shall be paid by 
April 1, 1990. In the case of floor stocks taxes imposed after January 
1, 1990, the tax shall be paid by June 30 of the year in which the tax 
is imposed.

[T.D. 8370, 56 FR 56317, Nov. 4, 1991, as amended by T.D. 8622, 60 FR 
52852, Oct. 11, 1995]



Sec. 52.4682-5  Exports.

    (a) Overview. This section provides rules relating to the tax 
imposed under section 4681 on ozone-depleting chemicals (ODCs) that are 
exported. In general, tax is not imposed on ODCs that a manufacturer or 
importer sells for export, or for resale by the purchaser to a second 
purchaser for export, if the procedural requirements set forth in 
paragraph (d) of this section are met. The tax benefit of this exemption 
is limited, however, to the manufacturer's or importer's exemption 
amount. Thus, if the tax that would otherwise be imposed under section 
4681 on ODCs that a manufacturer or importer sells for export exceeds 
this exemption amount, a tax equal to the excess is imposed on the ODCs. 
The exemption amount, which is determined separately for post-1989 ODCs 
and post-1990 ODCs, is calculated for each calendar year in accordance 
with the rules of paragraph (c) of this section. This section also 
provides rules under which a tax imposed under section 4681 on exported 
ODCs may be credited or refunded, subject to the same limit on tax 
benefits, if the procedural requirements set forth in paragraph (f) of 
this section are met. See Sec. 52.4681-1(c) for definitions relating to 
the tax on ODCs.
    (b) Exemption or partial exemption from tax--(1) In general. Except 
as provided in paragraph (b)(2) of this section, no tax is imposed on an 
ODC if the manufacturer or importer of the ODC sells the ODC in a 
qualifying sale for export (within the meaning of paragraph (d)(1) of 
this section).
    (2) Tax imposed if exemption amount exceeded--(i) Post-1989 ODCs. 
The tax imposed on post-1989 ODCs that a manufacturer or importer sells 
in qualifying sales for export during a calendar year is equal to the 
excess (if any) of--
    (A) The tax that would be imposed on the ODCs but for section 
4682(d)(3) and this section; over
    (B) The post-1989 ODC exemption amount for the calendar year 
determined under paragraph (c)(1) of this section.
    (ii) Post-1990 ODCs. The tax imposed on post-1990 ODCs that a 
manufacturer or importer sells in qualifying sales for export during a 
calendar year is equal to the excess (if any) of--
    (A) The tax that would be imposed on the ODCs but for section 
4682(d)(3) and this section; over
    (B) The post-1990 ODC exemption amount for the calendar year 
determined under paragraph (c)(2) of this section.
    (iii) Allocation of tax--(A) Post-1989 ODCs. The tax (if any) 
determined under paragraph (b)(2)(i) of this section may be allocated 
among the post-1989 ODCs on which it is imposed in any manner, provided 
that the amount allocated to any post-1989 ODC does not exceed the tax 
that would be imposed on such ODC but for section 4682(d)(3) and this 
section.
    (B) Post-1990 ODCs. The tax (if any) determined under paragraph 
(b)(2)(ii) of this section may be allocated among the post-1990 ODCs on 
which it is imposed in any manner, provided that the amount allocated to 
any post-1990 ODC does not exceed the tax that would be imposed on such 
ODC but for section 4682(d)(3) and this section.
    (c) Exemption amount--(1) Post-1989 ODC exemption amount. A 
manufacturer's or importer's post-1989 ODC exemption amount for a 
calendar year is the sum of the following amounts:
    (i) The 1986 export percentage of the aggregate tax that would (but 
for section 4682(d), section 4682(g), and this section) be imposed under 
section 4681 on the maximum quantity, determined without regard to 
additional production allowances, of post-1989 ODCs that the person is 
permitted to manufacture

[[Page 46]]

during the calendar year under rules prescribed by the Environmental 
Protection Agency (40 CFR part 82).
    (ii) The aggregate tax that would (but for section 4682(d), section 
4682(g), and this section) be imposed under section 4681 on post-1989 
ODCs that the person manufactures during the calendar year under any 
additional production allowance granted by the Environmental Protection 
Agency.
    (iii) The aggregate tax that would (but for section 4682(d), section 
4682(g), and this section) be imposed under section 4681 on post-1989 
ODCs imported by the person during the calendar year.
    (2) Post-1990 ODC exemption amount. A manufacturer's or importer's 
post-1990 ODC exemption amount for a calendar year is the sum of the 
following amounts:
    (i) The 1989 export percentage of the aggregate tax that would (but 
for section 4682(d), section 4682(g), and this section) be imposed under 
section 4681 on the maximum quantity, determined without regard to 
additional production allowances, of post-1990 ODCs the person is 
permitted to manufacture during the calendar year under rules prescribed 
by the Environmental Protection Agency.
    (ii) The aggregate tax that would (but for section 4682(d), section 
4682(g), and this section) be imposed under section 4681 on post-1990 
ODCs that the person manufactures during the calendar year under any 
additional production allowance granted by the Environmental Protection 
Agency.
    (iii) The aggregate tax that would (but for section 4682(d), section 
4682(g), and this section) be imposed under section 4681 on post-1990 
ODCs imported by the person during the calendar year.
    (3) Definitions--(i) 1986 export percentage. See section 
4682(d)(3)(B)(ii) for the meaning of the term 1986 export percentage.
    (ii) 1989 export percentage. See section 4682(d)(3)(C) for the 
meaning of the term 1989 export percentage.
    (d) Procedural requirements relating to tax-free sales for export--
(1) Qualifying sales--(i) In general. A sale of ODCs is a qualifying 
sale for export if--
    (A) The seller is the manufacturer or importer of the ODCs and the 
purchaser is a purchaser for export or for resale to a second purchaser 
for export;
    (B) At the time of the sale, the seller and the purchaser are 
registered with the Internal Revenue Service; and
    (C) At the time of the sale, the seller--
    (1) Has an unexpired certificate in substantially the form set forth 
in paragraph (d)(3)(ii) of this section from the purchaser; and
    (2) Relies on the certificate in good faith.
    (ii) Qualifying resale. A sale of ODCs is a qualifying resale for 
export if--
    (A) The seller acquired the ODCs in a qualifying sale for export and 
the purchaser is a second purchaser for export;
    (B) At the time of the sale, the seller and the purchaser are 
registered with the Internal Revenue Service; and
    (C) At the time of the sale, the seller--
    (1) Has an unexpired certificate in substantially the form set forth 
in paragraph (d)(3)(ii)(A) of this section from the purchaser of the 
ODCs; and
    (2) Relies on the certificate in good faith.
    (iii) Special rule relating to sales made before July 1, 1993. If a 
sale for export made before July 1, 1993, satisfies all the requirements 
of paragraph (d)(1)(i) or (ii) of this section other than those relating 
to registration, the sale will be treated as a qualifying sale (or 
resale) for export. Thus, a sale made before July 1, 1993, may be a 
qualifying sale (or resale) even if the parties to the sale are not 
registered and the required certificate does not contain statements 
regarding registration.
    (iv) Registration. Application for registration is made on Form 637 
(or any other form designated for the same use by the Commissioner) 
according to the instructions applicable to the form. A person is 
registered only if the district director has issued that person a letter 
of registration and it has not been revoked or suspended. The effective 
date of the registration must be no earlier than the date on which the 
district director signs the letter of registration. Each business unit 
that has, or is required to have, a separate employer identification 
number is treated as a separate person.

[[Page 47]]

    (2) Good faith reliance. The requirements of paragraph (d)(1) of 
this section are not satisfied with respect to a sale of ODCs and the 
sale is not a qualifying sale (or resale) if, at the time of the sale--
    (i) The seller has reason to believe that the ODCs are not purchased 
for export; or
    (ii) The Internal Revenue Service has notified the seller that the 
purchaser's registration has been revoked or suspended.
    (3) Certificate--(i) In general. The certificate required under 
paragraph (d)(1) of this section consists of a statement executed and 
signed under penalties of perjury by a person with authority to bind the 
purchaser, in substantially the same form as model certificates provided 
in paragraph (d)(3)(ii) of this section, and containing all information 
necessary to complete such model certificate. A new certificate must be 
given if any information in the current certificate changes. The 
certificate may be included as part of any business records normally 
used to document a sale. The certificate expires on the earliest of the 
following dates--
    (A) The date one year after the effective date of the certificate;
    (B) The date the purchaser provides a new certificate to the seller; 
or
    (C) The date the seller is notified by the Internal Revenue Service 
or the purchaser that the purchaser's registration has been revoked or 
suspended.
    (ii) Model certificates--(A) ODCs sold for export by the purchaser. 
If the purchaser will export the ODCs, the certificate must be in 
substantially the following form:

    CERTIFICATE OF PURCHASER OF CHEMICALS FOR EXPORT BY THE PURCHASER

  (To support tax-free sales under section 4682(d)(3) of the Internal 
                             Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
 (not more than one year
 after effective date)
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    Purchaser is registered with the Internal Revenue Service as a 
purchaser of ozone-depleting chemicals for export under registration 
number ----------. Purchaser's registration has not been suspended or 
revoked by the Internal Revenue Service.
    The following percentage of ozone-depleting chemicals purchased 
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)
________________________________________________________________________
(Taxpayer identifying number of seller)

are purchased for export by Purchaser.

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................................   ----------
CFC-12.....................................................   ----------
CFC-113....................................................   ----------
CFC-114....................................................   ----------
CFC-115....................................................   ----------
Halon-1211.................................................   ----------
Halon-1301.................................................   ----------
Halon-2402.................................................   ----------
Carbon tetrachloride.......................................   ----------
Methyl chloroform..........................................   ----------
 Other (specify)
 --------------............................................   ----------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account 
          number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser understands that Purchaser will be liable for tax imposed 
under section 4681 if Purchaser does not export the ODCs to which this 
certificate applies.

    Purchaser understands that any use of the ODCs to which this 
certificate applies other than for export may result in the revocation 
of Purchaser's registration.

    Purchaser will retain the business records needed to document the 
export of the ozone-depleting chemicals to which this certificate 
applies and will make such records available for inspection by 
Government officers.

    Purchaser has not been notified by the Internal Revenue Service that 
its registration has been revoked or suspended.

    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser

[[Page 48]]

and all parties making such fraudulent use of this certificate to a fine 
or imprisonment, or both, together with the costs of prosecution.

________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

    (B) ODCs sold by the purchaser for resale for export by the second 
purchaser. If the purchaser will resell the ODCs to a second purchaser 
for export by the second purchaser, the certificate must be in 
substantially the following form:

   CERTIFICATE OF PURCHASER OF CHEMICALS FOR RESALE FOR EXPORT BY THE 
                            SECOND PURCHASER

  (To support tax-free sales under section 4682(d)(3) of the Internal 
                             Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
 (not more than one year
 after effective date)
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    Purchaser is registered with the Internal Revenue Service as a 
purchaser of ozone-depleting chemicals for export under registration 
number ----------. Purchaser's registration has not been suspended or 
revoked by the Internal Revenue Service.
    The following percentage of ozone-depleting chemicals purchased 
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)
________________________________________________________________________
(Taxpayer identifying number of seller)

will be resold by Purchaser to persons (Second Purchasers) that certify 
to Purchaser that they are (1) registered with the Internal Revenue 
Service as purchasers of ozone-depleting chemicals for export and (2) 
purchasing the ozone-depleting chemicals for export.

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................................   ----------
CFC-12.....................................................   ----------
CFC-113....................................................   ----------
CFC-114....................................................   ----------
CFC-115....................................................   ----------
Halon-1211.................................................   ----------
Halon-1301.................................................   ----------
Halon-2402.................................................   ----------
Carbon tetrachloride.......................................   ----------
Methyl chloroform..........................................   ----------
 Other (specify)
--------------.............................................   ----------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account 
          number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser understands that Purchaser will be liable for tax imposed 
under section 4681 if Purchaser does not resell the ODCs to which this 
certificate applies to a Second Purchaser for export or export those 
ODCs.
    Purchaser understands that any use of the ODCs to which this 
certificate applies other than for resale to Second Purchasers for 
export may result in the revocation of Purchaser's registration.
    Purchaser will retain the business records needed to document the 
sales to Second Purchasers for export covered by this certificate and 
will make such records available for inspection by Government officers. 
Purchaser also will retain and make available for inspection by 
Government officers the certificates of its Second Purchasers.
    Purchaser has not been notified by the Internal Revenue Service that 
its registration has been revoked or suspended. In addition, the 
Internal Revenue Service has not notified Purchaser of the revocation or 
suspension of the registration of any Second Purchaser who will purchase 
ozone-depleting chemicals to which this certificate applies.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Name of Purchaser

[[Page 49]]

________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

    (4) Documentation of export--(i) After December 31, 1992. After 
December 31, 1992, to document the exportation of any ODCs, a person 
must have the evidence required by the Environmental Protection Agency 
as proof that the ODCs were exported.
    (ii) Before January 1, 1993. Before January 1, 1993, to document the 
exportation of any ODCs, a person must have evidence substantially 
similar to that required by the Environmental Protection Agency as proof 
that the ODCs were exported.
    (e) Purchaser liable for tax--(1) Purchaser in qualifying sale. The 
purchaser of ODCs in a qualifying sale for export is treated as the 
manufacturer of the ODC and is liable for any tax imposed under section 
4681 (determined without regard to exemptions for qualifying sales under 
this section or Sec. 52.4682-1) when it sells or uses the ODCs if that 
purchaser does not-
    (i) Export the ODCs and document the exportation of the ODCs in 
accordance with paragraph (d)(4) of this section; or
    (ii) Sell the ODCs in a qualifying resale for export.
    (2) Purchaser in qualifying resale. The purchaser of ODCs in a 
qualifying resale for export is treated as the manufacturer of the ODC 
and is liable for any tax imposed under section 4681 (determined without 
regard to exemptions for qualifying sales under this section or Sec. 
52.4682-1) when it sells or uses the ODCs if that purchaser does not 
export the ODCs and document the exportation of the ODCs in accordance 
with paragraph (d)(4) of this section.
    (f) Credit or refund--(1) In general. Except as provided in 
paragraph (f)(2) of this section, a manufacturer or importer that meets 
the conditions of paragraph (f)(3) of this section is allowed a credit 
or refund (without interest) of the tax it paid to the government under 
section 4681 on ODCs that are exported. Persons other than manufacturers 
and importers of ODCs cannot file claims for credit or refund of tax 
imposed under section 4681 on ODCs that are exported.
    (2) Limitation. The amount of credits or refunds of tax under this 
paragraph (f) is limited--
    (i) In the case of tax paid on post-1989 ODCs sold during a calendar 
year, to the amount (if any) by which the post-1989 exemption amount for 
the year exceeds the tax benefit provided to such post-1989 ODCs under 
paragraph (b) of this section; and
    (ii) In the case of tax paid on post-1990 ODCs sold during a 
calendar year, to the amount (if any) by which the post-1990 exemption 
amount for the year exceeds the tax benefit provided to such post-1990 
ODCs under paragraph (b) of this section.
    (3) Conditions to allowance of credit or refund. The conditions of 
this paragraph (f)(3) are met if the manufacturer or importer--
    (i) Documents the exportation of the ODCs in accordance with 
paragraph (d)(4) of this section; and
    (ii) Establishes that it has--
    (A) Repaid or agreed to repay the amount of the tax to the person 
that exported the ODC; or
    (B) Obtained the written consent of the exporter to the allowance of 
the credit or the making of the refund.
    (4) Procedural rules. See section 6402 and the regulations under 
that section for procedural rules relating to filing a claim for credit 
or refund of tax.
    (g) Examples. The following examples illustrate the provisions of 
this section. In each example, the sales are qualifying sales for export 
(within the meaning of paragraph (d)(1) of this section), all 
registration, certification, and documentation requirements of this 
section are met, and the ODCs sold for export are exported:

    Example 1. (i) Facts. D, a corporation, manufactures CFC-11, a post-
1989 ODC, and does not manufacture or import any other ODCs. In 1993, D 
manufactures 100,000 pounds of CFC-11, the maximum quantity D is allowed 
to manufacture in 1993 under EPA regulations. D has no additional 
production allowance from EPA for 1993. In 1993, the tax on CFC-11 is 
$3.35 per pound. D's 1986 export percentage for post-1989 ODCs is 50%. 
In 1993, D

[[Page 50]]

sells 80,000 pounds of CFC-11 in qualifying sales for export. The 
remainder of D's production is not exported.
    (ii) Components of limit on tax benefit. Under paragraph (c)(1) of 
this section, D's exemption amount for 1993 is equal to the sum of--
    (A) D's 1986 export percentage multiplied by the aggregate tax that 
would (but for section 4682(d), section 4682(g), and Sec. 52.4682-5) be 
imposed under section 4681 on the maximum quantity of post-1989 ODCs D 
is permitted to manufacture during 1993;
    (B) The aggregate tax that would (but for section 4682(d), section 
4682(g), and Sec. 52.4682-5) be imposed under section 4681 on post-1989 
ODCs that D manufactures during 1993 under an additional production 
allowance; and
    (C) The aggregate tax that would (but for section 4682(d), section 
4682(g), and Sec. 52.4682-5) be imposed under section 4681 on post-1989 
ODCs imported by D during 1993.
    (iii) Limit on tax benefit. The amounts described in paragraphs 
(ii)(B) and (C) of this Example 1 are equal to zero. Thus, D's 1993 
exemption amount is $167,500 (50% of $335,000 (the tax that would 
otherwise be imposed on 100,000 pounds of CFC-11 in 1993)).
    (iv) Application of limit on tax benefit. Under paragraph (b)(2) of 
this section, the tax imposed on the CFC-11 D sells for export is equal 
to the excess of the tax that would have been imposed on those ODCs but 
for section 4682(d) and Sec. 52.4682-5, over D's 1993 exemption amount. 
But for Sec. 52.4682-5, $268,000 ($3.35 x 80,000) of tax would have 
been imposed on the CFC-11 sold for export. Thus, $100,500 ($268,000 - 
$167,500) of tax is imposed on the CFC-11 sold for export.
    Example 2. (i) Facts. E, a corporation, manufactures CFC-11, a post-
1989 ODC, and does not manufacture or import any other ODCs. In 1993, E 
manufactures 100,000 pounds of CFC-11, the maximum quantity E is allowed 
to manufacture in 1993 under EPA regulations. E has no additional 
production allowance from EPA for 1993. In 1993, the tax on CFC-11 is 
$3.35 per pound. E's 1986 export percentage for post-1989 ODCs is 50%. 
In 1993, E sells 45,000 pounds of CFC-11 tax free in qualifying sales 
for export and pays tax under section 4681 on an additional 35,000 
pounds of exported CFC-11. The remainder of E's production is not 
exported.
    (ii) Limit on tax benefit. E's 1993 exemption amount is $167,500, 
(50% of $335,000 (the tax that would otherwise be imposed on 100,000 
pounds of CFC-11 in 1993)). The credit or refund allowed to E under 
paragraph (f) of this section is limited under paragraph (f)(2) of this 
section to the amount by which E's 1993 exemption amount exceeds E's 
1993 tax benefit under paragraph (b) of this section.
    (iii) Application of limit on tax benefit. Because E sold 45,000 
pounds of CFC-11 tax free in qualifying sales for export in 1993, E's 
1993 tax benefit under paragraph (b) of this section is $150,750 ($3.35 
x 45,000). Thus, the credit or refund allowed to E under paragraph (f) 
of this section is limited to $16,750 ($167,500-$150,750).
    Example 3. (i) Facts. F, a corporation, manufactures CFC-11, a post-
1989 ODC, and does not manufacture any other ODCs. F also imports CFC-
11. In 1993, F manufactures 60,000 pounds of CFC-11 (100,000 pounds is 
the maximum quantity F is allowed to manufacture in 1993 under EPA 
regulations) and imports 40,000 pounds. F has no additional production 
allowance from EPA for 1993. In 1993, the tax on CFC-11 is $3.35 per 
pound. F's 1986 export percentage for post-1989 ODCs is 50%. In 1993, F 
sells 45,000 pounds of CFC-11 tax free in qualifying sales for export 
and pays tax under section 4681 on an additional 35,000 pounds of 
exported CFC-11. The remainder of F's production is not exported.
    (ii) Limit on tax benefit. F's 1993 exemption amount is $301,500, 
($167,500 (50% of $335,000 (the tax that would otherwise be imposed on 
100,000 pounds of CFC-11 in 1993) plus $134,000 (the tax that would 
otherwise be imposed on the 40,000 pounds imported)). The credit or 
refund allowed to F under paragraph (f) of this section is limited under 
paragraph (f)(2) of this section to the amount by which F's 1993 
exemption amount exceeds F's 1993 tax benefit under paragraph (b) of 
this section.
    (iii) Application of limit on tax benefit. Because F sold 45,000 
pounds of CFC-11 tax free in qualifying sales for export in 1993, F's 
1993 tax benefit under paragraph (b) of this section is $150,750 ($3.35 
x 45,000). Thus, the credit or refund allowed to F under paragraph (f) 
of this section is limited to $150,750 ($301,500-$150,750). The 
limitation does not affect F's credit or refund because the tax F paid 
on exported ODCs is only $117,250 ($3.35 x 35,000).

    (h) Effective date. This section is effective January 1, 1993.

[T.D. 8622, 60 FR 52853, Oct. 11, 1995]



PART 53_FOUNDATION AND SIMILAR EXCISE TAXES--Table of Contents



                  Subpart A_Taxes on Investment Income

Sec.
53.4940-1 Excise tax on net investment income.

                     Subpart B_Taxes on Self-Dealing

53.4941(a)-1 Imposition of initial taxes.
53.4941(b)-1 Imposition of additional taxes.
53.4941(c)-1 Special rules.
53.4941(d)-1 Definition of self-dealing.
53.4941(d)-2 Specific acts of self-dealing.
53.4941(d)-3 Exceptions to self-dealing.
53.4941(d)-4 Transitional rules.
53.4941(e)-1 Definitions.
53.4941(f)-1 Effective dates.

[[Page 51]]

             Subpart C_Taxes on Failure To Distribute Income

53.4942(a)-1 Taxes for failure to distribute income.
53.4942(a)-2 Computation of undistributed income.
53.4942(a)-3 Qualifying distributions defined.
53.4942(b)-1 Operating foundations.
53.4942(b)-2 Alternative tests.
53.4942(b)-3 Determination of compliance with operating foundation 
          tests.

               Subpart D_Taxes on Excess Business Holdings

53.4943-1 General rule; purpose.
53.4943-2 Imposition of tax on excess business holdings of private 
          foundations.
53.4943-3 Determination of excess business holdings.
53.4943-4 Present holdings.
53.4943-5 Present holdings acquired by trust or a will.
53.4943-6 Five-year period to dispose of gifts, bequests, etc.
53.4943-7 Special rules for readjustments involving grandfathered 
          holdings.
53.4943-8 Business holdings; constructive ownership.
53.4943-9 Business holdings; certain periods.
53.4943-10 Business enterprise; definition.
53.4943-11 Effective date.

   Subpart E_Taxes on Investments Which Jeopardize Charitable Purpose

53.4944-1 Initial taxes.
53.4944-2 Additional taxes.
53.4944-3 Exception for program-related investments.
53.4944-4 Special rules.
53.4944-5 Definitions.
53.4944-6 Special rules for investments made prior to January 1, 1970.

                 Subpart F_Taxes on Taxable Expenditures

53.4945-1 Taxes on taxable expenditures.
53.4945-2 Propaganda influencing legislation.
53.4945-3 Influencing elections and carrying on voter registration 
          drives.
53.4945-4 Grants to individuals.
53.4945-5 Grants to organizations.
53.4945-6 Expenditures for noncharitable purposes.

                 Subpart G_Definitions and Special Rules

53.4946-1 Definitions and special rules.

            Subpart H_Application to Certain Nonexempt Trusts

53.4947-1 Application of tax.
53.4947-2 Special rules.

Subpart I_Tax on Investment Income of and Denial of Exemption to Certain 
                          Foreign Organizations

53.4948-1 Application of taxes and denial of exemption with respect to 
          certain foreign organizations.

             Subpart J_Black Lung Benefit Trust Excise Taxes

53.4951-1 Black lung trusts--taxes on self-dealing.
53.4952-1 Black lung trusts--taxes on taxable expenditures.

                   Subpart K_Second Tier Excise Taxes

53.4955-1 Tax on political expenditures.
53.4958-0 Table of contents.
53.4958-1 Taxes on excess benefit transactions.
53.4958-2 Definition of applicable tax-exempt organization.
53.4958-3 Definition of disqualified person.
53.4958-4 Excess benefit transaction.
53.4958-5 Transaction in which the amount of the economic benefit is 
          determined in whole or in part by the revenues of one or more 
          activities of the organization. [Reserved]
53.4958-6 Rebuttable presumption that a transaction is not an excess 
          benefit transaction.
53.4958-7 Correction.
53.4958-8 Special rules.
53.4961-1 Abatement of second tier taxes for correction within 
          correction period.
53.4961-2 Court proceedings to determine liability for second tier tax.
53.4963-1 Definitions.
53.4965-1 Overview.
53.4965-2 Covered tax-exempt entities.
53.4965-3 Prohibited tax shelter transactions.
53.4965-4 Definition of tax-exempt party to a prohibited tax shelter 
          transaction.
53.4965-5 Entity managers and related definitions.
53.4965-6 Meaning of ``knows or has reason to know''.
53.4965-7 Taxes on prohibited tax shelter transactions.
53.4965-8 Definition of net income and proceeds and standard for 
          allocating net income or proceeds to various periods.
53.4965-9 Effective/applicability dates.

                 Subpart L_Procedure and Administration

53.6001-1 Notice or regulations requiring records, statements, and 
          special returns.
53.6011-1 General requirement of return, statement or list.

[[Page 52]]

53.6011-4 Requirement of statement disclosing participation in certain 
          transactions by taxpayers.
53.6060-1 Reporting requirements for tax return preparers.
53.6061-1 Signing of returns and other documents.
53.6065-1 Verification of returns.
53.6071-1 Time for filing returns.
53.6071-1T Time for filing returns (temporary).
53.6081-1 Automatic extension of time for filing the return to report 
          taxes due under section 4951 for self-dealing with a nuclear 
          decommissioning fund.
53.6091-1 Place for filing chapter 42 tax returns.
53.6091-2 Exceptional cases.
53.6107-1 Tax return preparer must furnish copy of return or claim for 
          refund to taxpayer and must retain a copy or record.
53.6109-1 Tax return preparers furnishing identifying numbers for 
          returns or claims for refund filed.
53.6151-1 Time and place for paying tax shown on returns.
53.6161-1 Extension of time for paying tax or deficiency.
53.6165-1 Bonds where time to pay tax or deficiency has been extended.
53.6601-1 Interest on underpayment, nonpayment, or extensions of time 
          for payment, of tax.
53.6651-1 Failure to file tax return or to pay tax.
53.6694-1 Section 6694 penalties applicable to tax return preparer.
53.6694-2 Penalties for understatement due to an unreasonable position.
53.6694-3 Penalty for understatement due to willful, reckless, or 
          intentional conduct.
53.6694-4 Extension of period of collection when tax return preparer 
          pays 15 percent of a penalty for understatement of taxpayer's 
          liability and certain other procedural matters.
53.6695-1 Other assessable penalties with respect to the preparation of 
          tax returns or claims for refund for other persons.
53.6696-1 Claims for credit or refund by tax return preparers.
53.7101-1 Form of bonds.
53.7701-1 Tax return preparer.

    Authority: 26 U.S.C. 7805.
    Section 53.6060-1 also issued under 26 U.S.C. 6060(a);
    Section 53.6081-1 also issued under 26 U.S.C. 6081(a);
    Section 53.6109-1 also issued under 26 U.S.C. 6109(a);
    Section 53.6109-2 also issued under 26 U.S.C. 6109(a);
    Section 53.6695-1 also issued under 26 U.S.C. 6695(b).



                  Subpart A_Taxes on Investment Income



Sec. 53.4940-1  Excise tax on net investment income.

    (a) In general. For taxable years beginning after September 30, 
1977, section 4940 imposes an excise tax of 2 percent of the net 
investment income (as defined in section 4940(c) and paragraph (c) of 
this section) of a tax-exempt private foundation (as defined in section 
509). For taxable years beginning after December 31, 1969, and before 
October 1, 1977, the tax imposed by section 4940 is 4 percent of the net 
investment income. This tax will be reported on the form the foundation 
is required to file under section 6033 for the taxable year and will be 
paid annually at the time prescribed for filing such annual return 
(determined without regard to any extension of time for filing). In 
addition, an excise tax is imposed in the manner prescribed in paragraph 
(b) of this section on certain non-exempt private foundations (including 
certain non-exempt charitable trusts). Except as provided in the 
succeeding sentence, this tax is to be reported by means of a schedule 
attached to the organization's income tax return. For taxable years 
ending on or after December 31, 1975, the tax imposed by section 4940(b) 
and paragraph (b) of this section on a trust described in section 
4947(a)(1) which is a private foundation shall be reported on Form 5227. 
The tax imposed by section 4940(b) and this section is to be paid 
annually at the time the organization is required to pay its income 
taxes imposed under subtitle A. Except as otherwise provided herein, no 
exclusions or deductions from gross investment income or credits against 
tax are allowable under this section.
    (b) Taxable foundations. (1) The excise tax imposed under section 
4940 on private foundations which are not exempt from taxation under 
section 501(a) is equal to:
    (i) The amount (if any) by which the sum of
    (A) The tax on net investment income imposed under section 4940(a), 
computed as if such private foundation were exempt from taxation under 
section 501(a) and described in section 501(c)(3) for the taxable year, 
plus

[[Page 53]]

    (B) The amount of the tax which would have been imposed under 
section 511 for such taxable year if such private foundation had been 
exempt from taxation under section 501(a), exceeds.
    (ii) The tax imposed under subtitle A on such private foundation for 
the taxable year.
    (2) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. Assume that the tax liability under subtitle A for 
private foundation X, which is not exempt from taxation under section 
501(a) for 1970, is $10,000. Had X been exempt under section 501(a) for 
1970, the tax imposed under section 4940(a) would have been $4,000 and 
the tax imposed under section 511 would have been $7,000. The excess of 
the sum of the taxes which would have been imposed under sections 
4940(a) and 511 ($11,000) over the tax that was imposed under subtitle A 
($10,000) is $1,000, the amount of the tax imposed on such organization 
under section 4940(b).
    Example 2. Assume the facts stated in Example (1), except that the 
tax liability under subtitle A is $15,000 rather than $10,000. Because 
the sum of the taxes which would have been imposed under sections 
4940(a) and 511 ($11,000) does not exceed the tax that was imposed under 
subtitle A ($15,000), there is no tax imposed under section 4940(b) with 
respect to such foundation.

    (c) Net investment income defined--(1) In general. For purposes of 
section 4940(a), net investment income of a private foundation is the 
amount by which:
    (i) The sum of the gross investment income (as defined in section 
4940(c)(2) and paragraph (d) of this section) and the capital gain net 
income (net capital gain for taxable years beginning before January 1, 
1977) (within the meaning of section 4940(c)(4) and paragraph (f) of 
this section) exceeds
    (ii) The deductions allowed by section 4940(c)(3) and paragraph (e) 
of this section.

Except to the extent inconsistent with the provisions of this section, 
net investment income shall be determined under the principles of 
Subtitle A.
    (2) Tax-exempt income. For purposes of computing net investment 
income under section 4940, the provisions of section 103 (relating to 
interest on certain governmental obligations) and section 265 (relating 
to expenses and interest relating to tax-exempt income) and the 
regulations thereunder shall apply.
    (d) Gross investment income--(1) In general. For purposes of 
paragraph (c) of this section, ``gross investment income'' means the 
gross amounts of income from interest, dividends, rents, and royalties 
(including overriding royalties) received by a private foundation from 
all sources, but does not include such income to the extent included in 
computing the tax imposed by section 511. Under this definition, 
interest, dividends, rents, and royalties derived from assets devoted to 
charitable activities are includible in gross investment income. 
Therefore, for example, interest received on a student loan would be 
includible in the gross investment income of a private foundation making 
such loan. For purposes of paragraph (c) of this section, gross 
investment income also includes the items of investment income described 
in Sec. 1.512(b)-1(a).
    (2) Certain estate and trust disbursements. In the case of a 
distribution from an estate or a trust described in section 4947(a) (1) 
or (2), such distribution shall not retain its character in the hands of 
the distributee for purposes of computing the tax under section 4940; 
except that, in the case of a distribution from a trust described in 
section 4947(a)(2), the income of such trust attributable to transfers 
in trust after May 26, 1969, shall retain its character in the hands of 
a distributee private foundation for purposes of section 4940 (unless 
such income is taken into account because of the application of section 
671).
    (3) Treatment of certain distributions in redemption of stock. For 
purposes of applying section 302(b)(1), any distribution made to a 
private foundation by a disqualified person (as defined in section 
4946(a)), in redemption of stock held by such private foundation in a 
business enterprise shall be treated as not essentially equivalent to a 
dividend if all of the following conditions are satisfied: (i) Such 
redemption is of stock which was owned by a private foundation on May 
26, 1969 (or which is acquired by a private foundation under the terms 
of a trust which was irrevocable on May 26, 1969, or under the terms of 
a will executed on or before

[[Page 54]]

such date, which is in effect on such date and at all times thereafter, 
or would have passed under such a will but before that time actually 
passes under a trust which would have met the test of this subdivision 
but for the fact that the trust was revocable (but was not in fact 
revoked)); (ii) such foundation is required to dispose of such property 
in order not to be liable for tax under section 4943 (relating to taxes 
on excess business holdings); and (iii) such foundation receives in 
return an amount which equals or exceeds the fair market value of such 
property at the time of such disposition or at the time a contract for 
such disposition was previously executed in a transaction which would 
not constitute a prohibited transaction (within the meaning of section 
503(b) or the corresponding provisions of prior law). In the case of a 
disposition before January 1, 1975, section 4943 shall be applied 
without taking section 4943(c) (4) into account. A distribution which 
otherwise qualifies under section 302 as a distribution in part or full 
payment in exchange for stock shall not be treated as essentially 
equivalent to a dividend because it does not meet the requirements of 
this subparagraph.
    (e) Deductions--(1) In general. (i) For purposes of computing net 
investment income, there shall be allowed as a deduction from gross 
investment income all the ordinary and necessary expenses paid or 
incurred for the production or collection of gross investment income or 
for the management, conservation, or maintenance of property held for 
the production of such income, determined with the modifications set 
forth in subparagraph (2) of this paragraph. Such expenses include that 
portion of a private foundation's operating expenses which is paid or 
incurred for the production or collection of gross investment income. 
Taxes paid or incurred under this section are not paid or incurred for 
the production or collection of gross investment income. A private 
foundation's operating expenses include compensation of officers, other 
salaries and wages of employees, outside professional fees, interest, 
and rent and taxes upon property used in the foundation's operations. 
Where a private foundation's officers or employees engage in activities 
on behalf of the foundation for both investment purposes and for exempt 
purposes, compensation and salaries paid to such officers or employees 
must be allocated between the investment activities and the exempt 
activities. To the extent a private foundation's expenses are taken into 
account in computing the tax imposed by section 511, they shall not be 
deductible for purposes of computing the tax imposed by section 4940.
    (ii) Where only a portion of property produces, or is held for the 
production of, income subject to the section 4940 excise tax, and the 
remainder of the property is used for exempt purposes, the deductions 
allowed by section 4940(c)(3) shall be apportioned between the exempt 
and non-exempt uses.
    (iii) No amount is allowable as a deduction under this section to 
the extent it is paid or incurred for purposes other than those 
described in subdivision (i) of this subparagraph. Thus, for example, 
the deductions prescribed by the following sections are not allowable: 
(1) The charitable deduction prescribed under section 170 and 642(c); 
(2) the net operating loss deduction prescribed under section 172; and 
(3) the special deductions prescribed under Part VIII, Subchapter B, 
Chapter 1.
    (2) Deduction modifications. The following modifications shall be 
made in determining deductions otherwise allowable under this paragraph:
    (i) The depreciation deduction shall be allowed, but only on the 
basis of the straight line method provided in section 167(b)(1).
    (ii) The depletion deduction shall be allowed, but such deduction 
shall be determined without regard to section 613, relating to 
percentage depletion.
    (iii) The basis to be used for purposes of the deduction allowed for 
depreciation or depletion shall be the basis determined under the rules 
of Part II of Subchapter O of Chapter 1, subject to the provisions of 
section 4940(c)(3)(B), and without regard to section 4940(c)(4)(B), 
relating to the basis for determining gain, or section 362(c). Thus, a 
private foundation must reduce the cost or other substituted or 
transferred basis by an amount equal to the straight line depreciation 
or cost depletion, without regard to whether the

[[Page 55]]

foundation deducted such depreciation or depletion during the period 
prior to its first taxable year beginning after December 31, 1969. 
However, where a private foundation has previously taken depreciation or 
depletion deductions in excess of the amount which would have been taken 
had the straight line or cost method been employed, such excess 
depreciation or depletion also shall be taken into account to reduce 
basis. If the facts necessary to determine the basis of property in the 
hands of the donor or the last preceding owner by whom it was not 
acquired by gift are unknown to a donee private foundation, then the 
original basis to such foundation of such property shall be determined 
under the rules of Sec. 1.1015-1(a)(3).
    (iv) The deduction for expenses paid or incurred in any taxable year 
for the production of gross investment income earned as an incident to a 
charitable function shall be no greater than the income earned from such 
function which is includible as gross investment income for such year. 
For example, where rental income is incidentally realized in 1971 from 
historic buildings held open to the public, deductions for amounts paid 
or incurred in 1971 for the production of such income shall be limited 
to the amount of rental income includible as gross investment income for 
1971.
    (f) Capital gain and losses--(1) General rule. In determining 
capital gain net income (net capital gain for taxable years beginning 
before January 1, 1977) for purposes of the tax imposed by section 4940, 
there shall be taken into account only capital gains and losses from the 
sale or other disposition of property held by a private foundation for 
investment purposes (other than program-related investments, as defined 
in section 4944(c)), and property used for the production of income 
included in computing the tax imposed by section 511 except to the 
extent gain or loss from the sale or other disposition of such property 
is taken into account for purposes of such tax. For taxable years 
beginning after December 31, 1972, property shall be treated as held for 
investment purposes even though such property is disposed of by the 
foundation immediately upon its receipt, if it is property of a type 
which generally produces interest, dividends, rents, royalties, or 
capital gains through appreciation (for example, rental real estate, 
stock, bonds, mineral interests, mortgages, and securities). Under this 
subparagraph, gains and losses from the sale or other disposition of 
property used for the exempt purposes of the private foundation are 
excluded. For example, gain or loss on the sale of the buildings used 
for the exempt activities of a private foundation would not be subject 
to the section 4940 tax. Where the foundation uses property for its 
exempt purposes, but also incidentally derives income from such property 
which is subject to the tax imposed by section 4940(a), any gain or loss 
resulting from the sale or other disposition of such property is not 
subject to the tax imposed by section 4940(a). For example, if a tax-
exempt private foundation maintains buildings of a historical nature and 
keeps them open for public inspection, but requires a number of its 
employees to live in these buildings and charges the employees rent, the 
rent would be subject to the tax imposed by section 4940(a), but any 
gain or loss resulting from the sale of such property would not be 
subject to such tax. However, where the foundation uses property for 
both exempt purposes and (other than incidentally) for investment 
purposes (for example, a building in which the foundation's charitable 
and investment activities are carried on), that portion of any gain or 
loss from the sale or other disposition of such property which is 
allocable to the investment use of such property must be taken into 
account in computing capital gain net income (net capital gain for 
taxable years beginning before January 1, 1977) for such taxable year. 
For purposes of this paragraph, a distribution of property for purposes 
described in section 170(c) (1) or (2)(B) which is a qualifying 
distribution under section 4942 shall not be treated as a sale or other 
disposition of property.
    (2) Basis. (i) The basis for purposes of determining gain from the 
sale or other disposition of property shall be the greater of:
    (A) Fair market value on December 31, 1969, plus or minus all 
adjustments

[[Page 56]]

after December 31, 1969, and before the date of disposition under the 
rules of Part II of Subchapter O of Chapter 1, provided that the 
property was held by the private foundation on December 31, 1969, and 
continuously thereafter to the date of disposition, or
    (B) Basis as determined under the rules of Part II of Subchapter O 
of Chapter 1,

subject to the provisions of section 4940(c)(3)(B) (and without regard 
to section 362(c)).
    (ii) For purposes of determining loss from the sale or other 
disposition of property, basis as determined in subdivision (i)(B) of 
this subparagraph shall apply.
    (3) Losses. Where the sale or other disposition of property referred 
to in section 4940(c)(4)(A) results in a capital loss, such loss may be 
subtracted from capital gains from the sale or other disposition of 
other such property during the same taxable year, but only to the extent 
of such gains. Should losses from the sale or other disposition of such 
property exceed gains from the sale or other disposition of such 
property during the same taxable year, such excess may not be deducted 
from gross investment income under section 4940(c)(3) in any taxable 
year, nor may such excess by used to reduce gains in either prior or 
future taxable years, regardless of whether the foundation is a 
corporation or a trust.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. A private foundation holds certain depreciable real 
property on December 31, 1969, having a basis of $102,000. The fair 
market value of such property on that date was $100,000. For its taxable 
year 1970 the foundation was allowed depreciation for such property of 
$5,100 on the straight line method, the allowable amount computed on the 
$102,000 basis. The property was sold on January 1, 1971, for $100,000. 
Because fair market value on December 31, 1969, less straight line 
depreciation of $5,100 ($94,900) is less than basis as determined by 
Part II of Subchapter O of Chapter 1, $96,900 ($102,000 less $5,100), a 
gain of $3,100 is recognized (i.e., sales price of $100,000 less the 
greater of the two possible bases).
    Example 2. Assume the same facts in example 1, except that the sale 
price was $95,000. Because the sale price was $1,900 less than the basis 
for loss ($96,900 as determined by the application of subparagraph 
(2)(ii) of this paragraph), there is a capital loss of $1,900 which may 
be deducted against capital gains for 1971 (if any) in determining net 
capital gain (capital gain net income for taxable years beginning after 
December 31, 1976).
    Example 3. A private foundation holds certain depreciable real 
property on December 31, 1969, having a basis of $102,000. The fair 
market value of such property on that date was $110,000. For its taxable 
year 1970 the foundation was allowed depreciation for such property of 
$5,100 on the straight line method, the allowable amount computed on the 
$102,000 basis. The property was sold on January 1, 1971, for $100,000. 
Fair market value on December 31, 1969, less straight line depreciation 
of $5,100 ($104,900) exceeds basis as determined by Part II of 
Subchapter O of Chapter 1, $96,900 ($102,000 less $5,100), and will be 
used for purposes of determining gain. Because basis for purposes of 
determining gain exceeds sale price, there is no gain. There is no loss 
because basis for purposes of determining loss ($96,900) is less than 
sale price.

[T.D. 7250, 38 FR 868, Jan. 5, 1973; 38 FR 7549, Mar. 23, 1973, as 
amended by T.D. 7407, 41 FR 9321, Mar. 4, 1976; T.D. 7606, 44 FR 18971, 
Mar. 30, 1979; T.D. 7728, 45 FR 72651, Nov. 3, 1980; T.D. 8423, 57 FR 
33444, July 29, 1992]



                     Subpart B_Taxes on Self-Dealing

    Source: T.D. 7270, 38 FR 9493, Apr. 17, 1973, unless otherwise 
noted.



Sec. 53.4941(a)-1  Imposition of initial taxes.

    (a) Tax on self-dealer--(1) In general. Section 4941(a)(1) of the 
code imposes an excise tax on each act of self-dealing between a 
disqualified person (as defined in section 4946(a)) and a private 
foundation. Except as provided in subparagraph (2) of this paragraph, 
this tax shall be imposed on a disqualified person even though he had no 
knowledge at the time of the act that such act constituted self-dealing. 
Notwithstanding the preceding two sentences, however, a transaction 
between a disqualified person and a private foundation will not 
constitute an act of self-dealing if:
    (i) The transaction is a purchase or sale of securities by a private 
foundation through a stockbroker where normal trading procedures on a 
stock exchange or recognized over-the-counter market are followed;
    (ii) Neither the buyer nor the seller of the securities nor the 
agent of either

[[Page 57]]

knows the identity of the other party involved; and
    (iii) The sale is made in the ordinary course of business, and does 
not involve a block of securities larger than the average daily trading 
volume of that stock over the previous 4 weeks.

However, the preceding sentence shall not apply to a transaction 
involving a dealer who is a disqualified person acting as a principal or 
to a transaction which is an act of self-dealing pursuant to section 
4941(d)(1)(B) and Sec. 53.4941(d)-2 (c)(1). The tax imposed by section 
4941(a)(1) is at the rate of 5 percent of the amount involved (as 
defined in section 4941(e)(2) and Sec. 53.4941(e)-1(b)) with respect to 
the act of self-dealing for each year or partial year in the taxable 
period (as defined in section 4941(e)(1)) and shall be paid by any 
disqualified person (other than a foundation manager acting only in the 
capacity of a foundation manager) who participates in the act of self-
dealing. However, if a foundation manager is also acting as a self-
dealer, he may be liable for both the tax imposed by section 4941(a)(1) 
and the tax imposed by section 4941(a)(2).
    (2) Government officials. In the case of a government official (as 
defined in sec. 4946(a)), the tax shall be imposed upon such government 
official who participates in an act of self-dealing, only if he knows 
that such act is an act of self-dealing. See paragraph (b)(3) of this 
section for a definition of knowing.
    (3) Participation. For purposes of this paragraph, a disqualified 
person shall be treated as participating in an act of self-dealing in 
any case in which he engages or takes part in the transaction by himself 
or with others, or directs any person to do so.
    (b) Tax on foundation manager--(1) In general. Section 4941(a)(2) of 
the code imposes an excise tax on the participation of any foundation 
manager in an act of self-dealing between a disqualified person and a 
private foundation. This tax is imposed only in cases in which the 
following circumstances are present:
    (i) A tax is imposed by section 4941(a)(1),
    (ii) Such participating foundation manager knows that the act is an 
act of self-dealing, and
    (iii) The participation by the foundation manager is willful and is 
not due to reasonable cause.

The tax imposed by section 4941(a)(2) is at the rate of 2\1/2\ percent 
of the amount involved with respect to the act of self-dealing for each 
year or partial year in the taxable period and shall be paid by any 
foundation manager described in subdivisions (ii) and (iii) of this 
subparagraph.
    (2) Participation. The term ``participation'' shall include silence 
or inaction on the part of a foundation manager where he is under a duty 
to speak or act, as well as any affirmative action by such manager. 
However, a foundation manager will not be considered to have 
participated in an act of self-dealing where he has opposed such act in 
a manner consistent with the fulfillment of his responsibilities to the 
private foundation.
    (3) Knowing. For purposes of section 4941, a person shall be 
considered to have participated in a transaction ``knowing'' that it is 
an act of self-dealing only if:
    (i) He has actual knowledge of sufficient facts so that, based 
solely upon such facts, such transaction would be an act of self-
dealing,
    (ii) He is aware that such an act under these circumstances may 
violate the provisions of Federal tax law governing self-dealing, and
    (iii) He negligently fails to make reasonable attempts to ascertain 
whether the transaction is an act of self-dealing, or he is in fact 
aware that it is such an act.

For purposes of this part and Chapter 42, the term ``knowing'' does not 
mean ``having reason to know''. However, evidence tending to show that a 
person has reason to know of a particular fact or particular rule is 
relevant in determining whether he had actual knowledge of such fact or 
rule. Thus, for example, evidence tending to show that a person has 
reason to know of sufficient facts so that, based solely upon such 
facts, a transaction would be an act of self-dealing is relevant in 
determining whether he has actual knowledge of such facts.
    (4) Willful. Participation by a foundation manager shall be deemed 
willful if

[[Page 58]]

it is voluntary, conscious, and intentional. No motive to avoid the 
restrictions of the law or the incurrence of any tax is necessary to 
make the participation willful. However, participation by a foundation 
manager is not willful if he does not know that the transaction in which 
he is participating is an act of self-dealing.
    (5) Due to reasonable cause. A foundation manager's participation is 
due to reasonable cause if he has exercised his responsibility on behalf 
of the foundation with ordinary business care and prudence.
    (6) Advice of counsel. If a person, after full disclosure of the 
factual situation to legal counsel (including house counsel), relies on 
the advice of such counsel expressed in a reasoned written legal opinion 
that an act is not an act of self-dealing under section 4941, although 
such act is subsequently held to be an act of self-dealing, the person's 
participation in such act will ordinarily not be considered ``knowing'' 
or ``willful'' and will ordinarily be considered ``due to reasonable 
cause'' within the meaning of section 4941(a)(2). For purposes of this 
subparagraph, a written legal opinion will be considered ``reasoned'' 
even if it reaches a conclusion which is subsequently determined to be 
incorrect so long as such opinion addresses itself to the facts and 
applicable law. However, a written legal opinion will not be considered 
``reasoned'' if it does nothing more than recite the facts and express a 
conclusion. However, the absence of advice of counsel with respect to an 
act shall not, by itself, give rise to any inference that a person 
participated in such act knowingly, willfully, or without reasonable 
cause.
    (c) Burden of proof. For provisions relating to the burden of proof 
in cases involving the issue whether a foundation manager or a 
government official has knowingly participated in an act of self-
dealing, see section 7454(b).

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7299, 38 FR 
35304, Dec. 27, 1973]



Sec. 53.4941(b)-1  Imposition of additional taxes.

    (a) Tax on self-dealer. Section 4941(b)(1) of the Code imposes an 
excise tax in any case in which an initial tax is imposed by section 
4941(a)(1) on an act of self-dealing by a disqualified person with a 
private foundation and the act is not corrected within the taxable 
period (as defined in Sec. 53.4941(e)-1(a)). The tax imposed by section 
4941(b)(1) is at the rate of 200 percent of the amount involved and 
shall be paid by any disqualified person (other than a foundation 
manager action only in the capacity of a foundation manager) who 
participated in the act of self-dealing.
    (b) Tax on foundation manager. Section 4941(b)(2) of the Code 
imposes an excise tax to be paid by a foundation manager in any case in 
which a tax is imposed by section 4941(b)(1) and the foundation manager 
refused to agree to part or all of the correction of the self-dealing 
act. The tax imposed by section 4941(b)(2) is at the rate of 50 percent 
of the amount involved and shall be paid by any foundation manager who 
refused to agree to part or all of the correction of the self-dealing 
act. For the limitations on liability of a foundation manager, see Sec. 
53.4941(c)-1(b).

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 8084, 51 FR 
16301, May 2, 1986]



Sec. 53.4941(c)-1  Special rules.

    (a) Joint and several liability. (1) In any case where more than one 
person is liable for the tax imposed by any paragraph of section 4941 
(a) or (b), all such persons shall be jointly and severally liable for 
the taxes imposed under such paragraph with respect to such act of self-
dealing.
    (2) The provisions of this paragraph may be illustrated by the 
following example:

    Example. A and B, who are managers of private foundation X, lend one 
of the foundation's paintings to G, a disqualified person, for display 
in G's office, in a transaction which gives rise to liability for tax 
under section 4941(a)(2) (relating to tax on foundation managers). An 
initial tax is imposed on both A and B with respect to the act of 
lending the foundation's painting to G. A and B are jointly and 
severally liable for the tax.

    (b) Limits on liability for management. (1) The maximum aggregate 
amount of tax collectible under section 4941(a)(2) from all foundation 
managers with respect to any one act of self-dealing shall be $10,000, 
and the maximum aggregate amount of tax collectible

[[Page 59]]

under section 4941(b)(2) from all foundation managers with respect to 
any one act of self-dealing shall be $10,000.
    (2) The provisions of this paragraph may be illustrated by the 
following example:

    Example. A, a disqualified person with respect to private foundation 
Y, sells certain real estate having a fair market value of $500,000 to Y 
for $500,000 in cash. B, C, and D, all the managers of foundation Y, 
authorized the purchase on Y's behalf knowing that such purchase was an 
act of self-dealing. The actions of B, C, and D in approving the 
purchase were willful and not due to reasonable cause. Initial taxes are 
imposed upon the foundation managers under subsections (a)(2) and (c)(2) 
of section 4941. The tax to be paid by the foundation managers is 
$10,000 (the lesser of $10,000 or 2\1/2\ percent of the amount 
involved). The managers are jointly and severally liable for this 
$10,000, and this sum may be collected by the Internal Revenue Service 
from any one of them.



Sec. 53.4941(d)-1  Definition of self-dealing.

    (a) In general. For purposes of section 4941, the term self-dealing 
means any direct or indirect transaction described in Sec. 53.4941(d)-
2. For purposes of this section, it is immaterial whether the 
transaction results in a benefit or a detriment to the private 
foundation. The term ``self-dealing'' does not, however, include a 
transaction between a private foundation and a disqualified person where 
the disqualified person status arises only as a result of such 
transaction. For example, the bargain sale of property to a private 
foundation is not a direct act of self-dealing if the seller becomes a 
disqualified person only by reason of his becoming a substantial 
contributor as a result of the bargain element of the sale. For the 
effect of sections 4942, 4943, 4944, and 4945 upon an act of self-
dealing which also results in the imposition of tax under one or more of 
such sections, see the regulations under those sections.
    (b) Indirect self-dealing--(1) Certain business transactions. The 
term ``indirect self-dealing'' shall not include any transaction 
described in Sec. 53.4941(d)-2 between a disqualified person and an 
organization controlled by a private foundation (within the meaning of 
paragraph (6)(5) of this section) if:
    (i) The transaction results from a business relationship which was 
established before such transaction constituted an act of self-dealing 
(without regard to this paragraph),
    (ii) The transaction was at least as favorable to the organization 
controlled by the foundation as an arm's-length transaction with an 
unrelated person, and
    (iii) Either:
    (a) The organization controlled by the foundation could have engaged 
in the transaction with someone other than a disqualified person only at 
a severe economic hardship to such organization, or
    (b) Because of the unique nature of the product or services provided 
by the organization controlled by the foundation, the disqualified 
person could not have engaged in the transaction with anyone else, or 
could have done so only by incurring severe economic hardship. See 
example (2) of subparagraph (8) of this paragraph.
    (2) Grants to intermediaries. The term ``indirect self-dealing'' 
shall not include a transaction engaged in with a government official by 
an intermediary organization which is a recipient of a grant from a 
private foundation and which is not controlled by such foundation 
(within the meaning of paragraph (6) (5) of this section) if the private 
foundation does not earmark the use of the grant for any named 
government official and there does not exist an agreement, oral or 
written, whereby the grantor foundation may cause the selection of the 
government official by the intermediary organization. A grant by a 
private foundation is earmarked if such grant is made pursuant to an 
agreement, either oral or written, that the grant will be used by any 
named individual. Thus, a grant by a private foundation shall not 
constitute an indirect act of self-dealing even though such foundation 
had reason to believe that certain government officials would derive 
benefits from such grant so long as the intermediary organization 
exercises control, in fact, over the selection process and actually 
makes the selection completely independently of the private foundation. 
See example (3) of subparagraph (8) of this paragraph.
    (3) Transactions during the administration of an estate or revocable 
trust. The

[[Page 60]]

term ``indirect self-dealing'' shall not include a transaction with 
respect to a private foundation's interest or expectancy in property 
(whether or not encumbered) held by an estate (or revocable trust, 
including a trust which has become irrevocable on a grantor's death), 
regardless of when title to the property vests under local law, if:
    (i) The administrator or executor of an estate or trustee of a 
revocable trust either:
    (a) Possesses a power of sale with respect to the property,
    (b) Has the power to reallocate the property to another beneficiary, 
or
    (c) Is required to sell the property under the terms of any option 
subject to which the property was acquired by the estate (or revocable 
trust);
    (ii) Such transaction is approved by the probate court having 
jurisdiction over the estate (or by another court having jurisdiction 
over the estate (or trust) or over the private foundation);
    (iii) Such transaction occurs before the estate is considered 
terminated for Federal income tax purposes pursuant to paragraph (a) of 
Sec. 1.641(b)-3 of this chapter (or in the case of a revocable trust, 
before it is considered subject to sec. 4947);
    (iv) The estate (or trust) receives an amount which equals or 
exceeds the fair market value of the foundation's interest or expectancy 
in such property at the time of the transaction, taking into account the 
terms of any option subject to which the property was acquired by the 
estate (or trust); and
    (v) With respect to transactions occurring after April 16, 1973, the 
transaction either:
    (a) Results in the foundation receiving an interest or expectancy at 
least as liquid as the one it gave up,
    (b) Results in the foundation receiving an asset related to the 
active carrying out of its exempt purposes, or
    (c) Is required under the terms of any option which is binding on 
the estate (or trust).
    (4) Transactions with certain organizations. A transaction between a 
private foundation and an organization which is not controlled by the 
foundation (within the meaning of subparagraph (5) of this paragraph), 
and which is not described in section 4946(a)(1) (E), (F), or (G) 
because persons described in section 4946(a)(1) (A), (B), (C), or (D) 
own no more than 35 percent of the total combined voting power or 
profits or beneficial interest of such organization, shall not be 
treated as an indirect act of self-dealing between the foundation and 
such disqualified persons solely because of the ownership interest of 
such persons in such organization.
    (5) Control. For purposes of this paragraph, an organization is 
controlled by a private foundation if the foundation or one or more of 
its foundation managers (acting only in such capacity) may, only by 
aggregating their votes or positions of authority, require the 
organization to engage in a transaction which if engaged in with the 
private foundation would constitute self-dealing. Similarly, for 
purposes of this paragraph, an organization is controlled by a private 
foundation in the case of such a transaction between the organization 
and a disqualified person, if such disqualified person, together with 
one or more persons who are disqualified persons by reason of such a 
person's relationship (within the meaning of section 4946(a)(1) (C) 
through (G)) to such disqualified person, may, only by aggregating their 
votes or positions of authority with that of the foundation, require the 
organization to engage in such a transaction. The ``controlled'' 
organization need not be a private foundation; for example, it may be 
any type of exempt or nonexempt organization including a school, 
hospital, operating foundation, or social welfare organization. For 
purposes of this paragraph, an organization will be considered to be 
controlled by a private foundation or by a private foundation and 
disqualified persons referred to in the second sentence of this 
subparagraph if such persons are able, in fact, to control the 
organization (even if their aggregate voting power is less than 50 
percent of the total voting power of the organization's governing body) 
or if one or more of such persons has the right to exercise veto power 
over the actions of such organization relevant to any potential acts of 
self-dealing. A private foundation shall not be regarded as having 
control over an organization merely because it exercises expenditure 
responsibility (as defined

[[Page 61]]

in section 4945 (d)(4) and (h)) with respect to contributions to such 
organization. See example (6) of subparagraph (8) of this paragraph.
    (6) Certain transactions involving limited amounts. The term 
``indirect self-dealing'' shall not include any transaction between a 
disqualified person and an organization controlled by a private 
foundation (within the meaning of subparagraph (5) of this paragraph) or 
between two disqualified persons where the foundation's assets may be 
affected by the transaction if:
    (i) The transaction arises in the normal and customary course of a 
retail business engaged in with the general public,
    (ii) In the case of a transaction between a disqualified person and 
an organization controlled by a private foundation, the transaction is 
at least as favorable to the organization controlled by the foundation 
as an arm's-length transaction with an unrelated person, and
    (iii) The total of the amounts involved in such transactions with 
respect to any one such disqualified person in any one taxable year does 
not exceed $5,000.

See example (7) of subparagraph (8) of this paragraph.
    (7) Applicability of statutory exceptions to indirect self-dealing. 
The term ``indirect self-dealing'' shall not include a transaction 
involving one or more disqualified persons to which a private foundation 
is not a party, in any case in which the private foundation, by reason 
of section 4941(d)(2), could itself engage in such a transaction. Thus, 
for example, even if a private foundation has control (within the 
meaning of subparagraph (5) of this paragraph) of a corporation, the 
corporation may pay to a disqualified person, except a government 
official, reasonable compensation for personal services.
    (8) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. Private foundation P owns the controlling interest of the 
voting stock of corporation X, and as a result of such interest, elects 
a majority of the board of directors of X. Two of the foundation 
managers, A and B, who are also directors of corporation X, form 
corporation Y for the purpose of building and managing a country club. A 
and B receive a total of 40 percent of Y's stock, making Y a 
disqualified person with respect to P under section 4946(a)(1)(E). In 
order to finance the construction and operation of the country club, Y 
requested and received a loan in the amount of $4 million from X. The 
making of the loan by X to Y shall constitute an indirect act of self-
dealing between P and Y.
    Example 2. Private foundation W owns the controlling interest of the 
voting stock of corporation X, a manufacturer of certain electronic 
computers. Corporation Y, a disqualified person with respect to W, owns 
the patent for, and manufactures, one of the essential component parts 
used in the computers. X has been making regular purchases of the 
patented component from Y since 1965, subject to the same terms as all 
other purchasers of such component parts. X could not buy similar 
components from another source. Consequently, X would suffer severe 
economic hardship if it could not continue to purchase these components 
from Y, since it would then be forced to develop a computer which could 
be constructed with other components. Under these circumstances, the 
continued purchase by X from Y of these components shall not be an 
indirect act of self-dealing between W and Y.
    Example 3. Private foundation Y made a grant to M University, an 
organization described in section 170(b)(1)(A)(ii), for the purpose of 
conducting a seminar to study methods for improving the administration 
of the judicial system. M is not controlled by Y within the meaning of 
subparagraph (5) of this paragraph. In conducting the seminar, M made 
payments to certain government officials. By the nature of the grant, Y 
had reason to believe that government officials would be compensated for 
participation in the seminar. M, however, had completely independent 
control over the selection of such participants. Thus, such grant by Y 
shall not constitute an indirect act of self-dealing with respect to the 
government officials.
    Example 4. A, a substantial contributor to P, a private foundation, 
bequeathed one-half of his estate to his spouse and one-half of his 
estate to P. Included in A's estate is a one-third interest in AB, a 
partnership. The other two-thirds interest in AB is owned by B, a 
disqualified person with respect to P. The one-third interest in AB was 
subject to an option agreement when it was acquired by the estate. The 
executor of A's estate sells the one-third interest in AB to B pursuant 
to such option agreement at the price fixed in such option agreement in 
a sale which meets the requirements of subparagraph (3) of this 
paragraph. Under these circumstances, the sale does not constitute an 
indirect act of self-dealing between B and P.

[[Page 62]]

    Example 5. A bequeathed $100,000 to his wife and a piece of 
unimproved real estate of equivalent value to private foundation Z, of 
which A was the creator and a foundation manager. Under the laws of 
State Y, to which the estate is subject, title to the real estate vests 
in the foundation upon A's death. However, the executor has the power 
under State law to reallocate the property to another beneficiary. 
During a reasonable period for administration of the estate, the 
executor exercises this power and distributes the $100,000 cash to the 
foundation and the real estate to A's wife. The probate court having 
jurisdiction over the estate approves the executor's action. Under these 
circumstances, the executor's action does not constitute an indirect act 
of self-dealing between the foundation and A's wife.
    Example 6. Private foundation P owns 20 percent of the voting stock 
of corporation W. A, a substantial contributor with respect to P, owns 
16 percent of the voting stock of corporation W. B, A's son, owns 15 
percent of the voting stock of corporation W. The terms of the voting 
stock are such that P, A, and B could vote their stock in a block to 
elect a majority of the board of directors of W. W is treated as 
controlled by P (within the meaning of subparagraph (5) of this 
paragraph) for purposes of this example A and B also own 50 percent of 
the stock of corporation Y, making Y a disqualified person with respect 
to P under section 4946(a)(1)(E). W makes a loan to Y of $1 million. The 
making of this loan by W to Y shall constitute an indirect act of self-
dealing between P and Y.
    Example 7. A, a disqualified person with respect to private 
foundation P, enters into a contract with corporation M, which is also a 
disqualified person with respect to P. P owns 20 percent of M's stock, 
and controls M within the meaning of subparagraph (5) of this paragraph. 
M is in the retail department store business. Purchases by A of goods 
sold by M in the normal and customary course of business at retail or 
higher prices are not indirect acts of self-dealing so long as the total 
of the amounts involved in all of such purchases by A in any one year 
does not exceed $5,000.

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended at 38 FR 12604, May 
14, 1973]



Sec. 53.4941(d)-2  Specific acts of self-dealing.

    Except as provided in Sec. 53.4941(d)-3 or Sec. 53.4941(d)-4:
    (a) Sale or exchange of property--(1) In general. The sale or 
exchange of property between a private foundation and a disqualified 
person shall constitute an act of self-dealing. For example, the sale of 
incidental supplies by a disqualified person to a private foundation 
shall be an act of self-dealing regardless of the amount paid to the 
disqualified person for the incidental supplies. Similarly, the sale of 
stock or other securities by a disqualified person to a private 
foundation in a ``bargain sale'' shall be an act of self-dealing 
regardless of the amount paid for such stock or other securities. An 
installment sale may be subject to the provisions of both section 
4941(d)(1)(A) and section 4941(d)(1)(B).
    (2) Mortgaged property. For purposes of subparagraph (1) of this 
paragraph, the transfer of real or personal property by a disqualified 
person to a private foundation shall be treated as a sale or exchange if 
the foundation assumes a mortgage or similar lien which was placed on 
the property prior to the transfer, or takes subject to a mortgage or 
similar lien which a disqualified person placed on the property within 
the 10-year period ending on the date of transfer. For purposes of this 
subparagraph, the term ``similar lien'' shall include, but is not 
limited to, deeds of trust and vendors' liens, but shall not include any 
other lien if such lien is insignificant in relation to the fair market 
value of the property transferred.
    (b) Leases--(1) In general. Except as provided in subparagraphs (2) 
and (3) of this paragraph, the leasing of property between a 
disqualified person and a private foundation shall constitute an act of 
self-dealing.
    (2) Certain leases without charge. The leasing of property by a 
disqualified person to a private foundation shall not be an act of self-
dealing if the lease is without charge. For purposes of this 
subparagraph, a lease shall be considered to be without charge even 
though the private foundation pays for janitorial services, utilities, 
or other maintenance costs it incurs for the use of the property, so 
long as the payment is not made directly or indirectly to a disqualified 
person.
    (3) Certain leases of office space. For taxable years beginning 
after December 31, 1979, the leasing of office space by a disqualified 
person to a private foundation shall not be an act of self-dealing if:

[[Page 63]]

    (i) The leased space is in a building in which there are other 
tenants who are not disqualified persons,
    (ii) The lease is pursuant to a binding lease which was in effect on 
October 9, 1969, or pursuant to renewals of such a lease,
    (iii) The execution of the lease was not a prohibited transaction 
(within the meaning of section 503(b) or the corresponding provisions of 
prior law) at the time of such execution, and
    (iv) The terms of the lease (or any renewal) reflect an arm's length 
transaction.

A lease or renewal of such lease is described in this subparagraph (3) 
only if it satisfies the requirements of Sec. 53.4941(d)-4(c) (1) and 
(2), applied without regard to the December 31, 1979 deadline described 
therein.
    (c) Loans--(1) In general. Except as provided in subparagraphs (2), 
(3), and (4) of this paragraph, the lending of money or other extension 
of credit between a private foundation and a disqualified person shall 
constitute an act of self-dealing. Thus, for example, an act of self-
dealing occurs where a third party purchases property and assumes a 
mortgage, the mortgagee of which is a private foundation, and 
subsequently the third party transfers the property to a disqualified 
person who either assumes liability under the mortgage or takes the 
property subject to the mortgage. Similarly, except in the case of the 
receipt and holding of a note pursuant to a transaction described in 
Sec. 53.4941(d)-1(b)(3), an act of self-dealing occurs where a note, 
the obligor of which is a disqualified person, is transferred by a third 
party to a private foundation which becomes the creditor under the note.
    (2) Loans without interest. Subparagraph (1) of this paragraph shall 
not apply to the lending of money or other extension of credit by a 
disqualified person to a private foundation if the loan or other 
extension of credit is without interest or other charge.
    (3) Certain evidences of future gifts. The making of a promise, 
pledge, or similar arrangement to a private foundation by a disqualified 
person, whether evidenced by an oral or written agreement, a promissory 
note, or other instrument of indebtedness, to the extent motivated by 
charitable intent and unsupported by consideration, is not an extension 
of credit (within the meaning of this paragraph) before the date of 
maturity.
    (4) General banking functions. Under section 4941(d)(2)(E) the 
performance by a bank or trust company which is a disqualified person of 
trust functions and certain general banking services for a private 
foundation is not an act of self-dealing, where the banking services are 
reasonable and necessary to carrying out the exempt purposes of the 
private foundation, if the compensation paid to the bank or trust 
company, taking into account the fair interest rate for the use of the 
funds by the bank or trust company, for such services is not excessive. 
The general banking services allowed by this subparagraph are:
    (i) Checking accounts, as long as the bank does not charge interest 
on any overwithdrawals,
    (ii) Savings accounts, as long as the foundation may withdraw its 
funds on no more than 30-days notice without subjecting itself to a loss 
of interest on its money for the time during which the money was on 
deposit, and
    (iii) Safekeeping activities.

See example (3) Sec. 53.4941(d)-3(c)(2).
    (d) Furnishing goods, services, or facilities--(1) In general. 
Except as provided in subparagraph (2) or (3) of this paragraph (or 
Sec. 53.4941(d)-3(b)), the furnishing of goods, services, or facilities 
between a private foundation and a disqualified person shall constitute 
an act of self-dealing. This subparagraph shall apply, for example, to 
the furnishing of goods, services, or facilities such as office space, 
automobiles, auditoriums, secretarial help, meals, libraries, 
publications, laboratories, or parking lots. Thus, for example, if a 
foundation furnishes personal living quarters to a disqualified person 
(other than a foundation manager or employee) without charge, such 
furnishing shall be an act of self-dealing.
    (2) Furnishing of goods, services, or facilities to foundation 
managers and employees. The furnishing of goods, services, or facilities 
such as those described in subparagraph (1) of this paragraph to a 
foundation manager in

[[Page 64]]

recognition of his services as a foundation manager, or to another 
employee (including an individual who would be an employee but for the 
fact that he receives no compensation for his services) in recognition 
of his services in such capacity, is not an act of self-dealing if the 
value of such furnishing (whether or not includible as compensation in 
his gross income) is reasonable and necessary to the performance of his 
tasks in carrying out the exempt purposes of the foundation and, taken 
in conjunction with any other payment of compensation or payment or 
reimbursement of expenses to him by the foundation, is not excessive. 
For example, if a foundation furnishes meals and lodging which are 
reasonable and necessary (but not excessive) to a foundation manager by 
reason of his being a foundation manager, then, without regard to 
whether such meals and lodging are excludable from gross income under 
section 119 as furnished for the convenience of the employer, such 
furnishing is not an act of self-dealing. For the effect of section 
4945(d)(5) upon an expenditure for unreasonable administrative expenses, 
see Sec. 53.4945-6(b)(2).
    (3) Furnishing of goods, services, or facilities by a disqualified 
person without charge. The furnishing of goods, services, or facilities 
by a disqualified person to a private foundation shall not be an act of 
self-dealing if they are furnished without charge. Thus, for example, 
the furnishing of goods such as pencils, stationery, or other incidental 
supplies, or the furnishing of facilities such as a building, by a 
disqualified person to a foundation shall be allowed if such supplies or 
facilities are furnished without charge. Similarly, the furnishing of 
services (even though such services are not personal in nature) shall be 
permitted if such furnishing is without charge. For purposes of this 
subparagraph, a furnishing of goods shall be considered without charge 
even though the private foundation pays for transportation, insurance, 
or maintenance costs it incurs in obtaining or using the property, so 
long as the payment is not made directly or indirectly to the 
disqualified person.
    (e) Payment of compensation. The payment of compensation (or payment 
or reimbursement of expenses) by a private foundation to a disqualified 
person shall constitute an act of self-dealing. See, however, Sec. 
53.4941(d)-3(c) for the exception for the payment of compensation by a 
foundation to a disqualified person for personal services which are 
reasonable and necessary to carry out the exempt purposes of the 
foundation.
    (f) Transfer or use of the income or assets of a private 
foundation--(1) In general. The transfer to, or use by or for the 
benefit of, a disqualified person of the income or assets of a private 
foundation shall constitute an act of self-dealing. For purposes of the 
preceding sentence, the purchase or sale of stock or other securities by 
a private foundation shall be an act of self-dealing if such purchase or 
sale is made in an attempt to manipulate the price of the stock or other 
securities to the advantage of a disqualified person. Similarly, the 
indemnification (of a lender) or guarantee (of repayment) by a private 
foundation with respect to a loan to a disqualified person shall be 
treated as a use for the benefit of a disqualified person of the income 
or assets of the foundation (within the meaning of this subparagraph). 
In addition, if a private foundation makes a grant or other payment 
which satisfies the legal obligation of a disqualified person, such 
grant or payment shall ordinarily constitute an act of self-dealing to 
which this subparagraph applies. However, if a private foundation makes 
a grant or payment which satisfies a pledge, enforceable under local 
law, to an organization described in section 501(c)(3), which pledge is 
made on or before April 16, 1973, such grant or payment shall not 
constitute an act of self-dealing to which this subparagraph applies so 
long as the disqualified person obtains no substantial benefit, other 
than the satisfaction of his obligation, from such grant or payment.
    (2) Certain incidental benefits. The fact that a disqualified person 
receives an incidental or tenuous benefit from the use by a foundation 
of its income or assets will not, by itself, make such use an act of 
self-dealing. Thus, the public

[[Page 65]]

recognition a person may receive, arising from the charitable activities 
of a private foundation to which such person is a substantial 
contributor, does not in itself result in an act of self-dealing since 
generally the benefit is incidental and tenuous. For example, a grant by 
a private foundation to a section 509(a) (1), (2), or (3) organization 
will not be an act of self-dealing merely because such organization is 
located in the same area as a corporation which is a substantial 
contributor to the foundation, or merely because one of the section 
509(a) (1), (2), or (3) organization's officers, directors, or trustees 
is also a manager of or a substantial contributor to the foundation. 
Similarly, a scholarship or a fellowship grant to a person other than a 
disqualified person, which is paid or incurred by a private foundation 
in accordance with a program which is consistent with:
    (i) The requirements of the foundation's exempt status under section 
501(c)(3),
    (ii) The requirements for the allowance of deductions under section 
170 for contributions made to the foundation, and
    (iii) The requirements of section 4945(g)(1),

will not be an act of self-dealing under section 4941(d)(1) merely 
because a disqualified person indirectly receives an incidental benefit 
from such grant. Thus, a scholarship or a fellowship grant made by a 
private foundation in accordance with a program to award scholarships or 
fellowship grants to the children of employees of a substantial 
contributor shall not constitute an act of self-dealing if the 
requirements of the preceding sentence are satisfied. For an example of 
the kind of scholarship program with an employment nexus that meets the 
above requirements, see Sec. 53.4945-4(b)(5) (example 1).
    (3) Non-compensatory indemnification of foundation managers against 
liability for defense in civil proceedings. (i) Except as provided in 
Sec. 53.4941(d)-3(c), section 4941(d)(1) shall not apply to the 
indemnification by a private foundation of a foundation manager, with 
respect to the manager's defense in any civil judicial or civil 
administrative proceeding arising out of the manager's performance of 
services (or failure to perform services) on behalf of the foundation, 
against all expenses (other than taxes, including taxes imposed by 
chapter 42, penalties, or expenses of correction) including attorneys' 
fees, judgments and settlement expenditures if--
    (A) Such expenses are reasonably incurred by the manager in 
connection with such proceeding; and
    (B) The manager has not acted willfully and without reasonable cause 
with respect to the act or failure to act which led to such proceeding 
or to liability for tax under chapter 42.
    (ii) Similarly, except as provided in Sec. 53.4941(d)-3(c), section 
4941(d)(1) shall not apply to premiums for insurance to make or to 
reimburse a foundation for an indemnification payment allowed pursuant 
to this paragraph (f)(3). Neither shall an indemnification or payment of 
insurance allowed pursuant to this paragraph (f)(3) be treated as part 
of the compensation paid to such manager for purposes of determining 
whether the compensation is reasonable under chapter 42.
    (4) Compensatory indemnification of foundation managers against 
liability for defense in civil proceedings. (i) The indemnification by a 
private foundation of a foundation manager for compensatory expenses 
shall be an act of self-dealing under this paragraph unless when such 
payment is added to other compensation paid to such manager the total 
compensation is reasonable under chapter 42. A compensatory expense for 
purposes of this paragraph (f) is--
    (A) Any penalty, tax (including a tax imposed by chapter 42), or 
expense of correction that is owed by the foundation manager;
    (B) Any expense not reasonably incurred by the manager in connection 
with a civil judicial or civil administrative proceeding arising out of 
the manager's performance of services on behalf of the foundation; or
    (C) Any expense resulting from an act or failure to act with respect 
to which the manager has acted willfully and without reasonable cause.
    (ii) Similarly, the payment by a private foundation of the premiums 
for an insurance policy providing liability insurance to a foundation 
manager for

[[Page 66]]

expenses described in this paragraph (f)(4) shall be an act of self-
dealing under this paragraph (f) unless when such premiums are added to 
other compensation paid to such manager the total compensation is 
reasonable under chapter 42.
    (5) Insurance allocation. A private foundation shall not be engaged 
in an act of self-dealing if the foundation purchases a single insurance 
policy to provide its managers both the noncompensatory and the 
compensatory coverage discussed in this paragraph (f), provided that the 
total insurance premium is allocated and that each manager's portion of 
the premium attributable to the compensatory coverage is included in 
that manager's compensation for purposes of determining reasonable 
compensation under chapter 42.
    (6) Indemnification. For purposes of this paragraph (f), the term 
indemnification shall include not only reimbursement by the foundation 
for expenses that the foundation manager has already incurred or 
anticipates incurring but also direct payment by the foundation of such 
expenses as the expenses arise.
    (7) Taxable income. The determination of whether any amount of 
indemnification or insurance premium discussed in this paragraph (f) is 
included in the manager's gross income for individual income tax 
purposes is made on the basis of the provisions of chapter 1 and without 
regard to the treatment of such amount for purposes of determining 
whether the manager's compensation is reasonable under chapter 42.
    (8) De minimis items. Any property or service that is excluded from 
income under section 132(a)(4) may be disregarded for purposes of 
determining whether the recipient's compensation is reasonable under 
chapter 42.
    (9) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a private foundation, makes a grant of $50,000 to the 
governing body of N City for the purpose of alleviating the slum 
conditions which exist in a particular neighborhood of N. Corporation P, 
a substantial contributor to M, is located in the same area in which the 
grant is to be used. Although the general improvement of the area may 
constitute an incidental and tenuous benefit to P, such benefit by 
itself will not constitute an act of self-dealing.
    Example 2. Private foundation X established a program to award 
scholarship grants to the children of employees of corporation M, a 
substantial contributor to X. After disclosure of the method of carrying 
out such program, X received a determination letter from the Internal 
Revenue Service stating that X is exempt from taxation under section 
501(c)(3), that contributions to X are deductible under section 170, and 
that X's scholarship program qualifies under section 4945(g)(1). A 
scholarship grant to a person not a disqualified person with respect to 
X paid or incurred by X in accordance with such program shall not be an 
indirect act of self-dealing between X and M.
    Example 3. Private foundation Y owns voting stock in corporation Z, 
the management of which includes certain disqualified persons with 
respect to Y. Prior to Z's annual stockholder meeting, the management 
solicits and receives the foundation's proxies. The transfer of such 
proxies in and of itself shall not be an act of self-dealing.
    Example 4. A, a disqualified person with respect to private 
foundation S, contributes certain real estate to S for the purpose of 
building a neighborhood recreation center in a particular 
underprivileged area. As a condition of the gift, S agrees to name the 
recreation center after A. Since the benefit to A is only incidental and 
tenuous, the naming of the recreation center, by itself, will not be an 
act of self-dealing.

    (g) Payment to a government official. Except as provided in section 
4941(d)(2)(G) or Sec. 53.4941(d)-3(e), the agreement by a private 
foundation to make any payment of money or other property to a 
government official, as defined in section 4946(c), shall constitute an 
act of self-dealing. For purposes of this paragraph, an individual who 
is otherwise described in section 4946(c) shall be treated as a 
government official while on leave of absence from the government 
without pay.

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7938, 49 FR 
3848, Jan. 31, 1984; T.D. 8639, 60 FR 65568, Dec. 20, 1995]



Sec. 53.4941(d)-3  Exceptions to self-dealing.

    (a) General rule. In general, a transaction described in section 
4941(d)(2) (B), (C), (D), (E), (F), (G), or (H) is not an act of self-
dealing. Section 4941(d)(2) (B), (C), and (H) provide limited exceptions 
to certain specific transactions, as described in paragraphs (b)(2), 
(b)(3),

[[Page 67]]

(c)(2), and (d)(3) of Sec. 53.4941(d)-2. Section 4941(d)(2) (D), (E), 
(F), and (G) and paragraphs (b) through (e) of this section described 
certain transactions which are not acts of self-dealing.
    (b) Furnishing of goods, services, or facilities to a disqualified 
person--(1) In general. Under section 4941(d)(2)(D), the furnishing of 
goods, services, or facilities by a private foundation to a disqualified 
person shall not be an act of self-dealing if such goods, services, or 
facilities are made available to the general public on at least as 
favorable a basis as they are made available to the disqualified person. 
This subparagraph shall not apply, however, in the case of goods, 
services, or facilities furnished later than May 16, 1973, unless such 
goods, services, or facilities are functionally related, within the 
meaning of section 4942(j)(5), to the exercise or performance by a 
private foundation of its charitable, educational, or other purpose or 
function constituting the basis for its exemption under section 
501(c)(3).
    (2) General public. For purposes of this paragraph, the term 
``general public'' shall include those persons who, because of the 
particular nature of the activities of the private foundation, would be 
reasonably expected to utilize such goods, services, or facilities. This 
paragraph shall not apply, however, unless there is a substantial number 
of persons other than disqualified persons who are actually utilizing 
such goods, services, or facilities. Thus, a private foundation which 
furnishes recreational or park facilities to the general public may 
furnish such facilities to a disqualified person provided they are 
furnished to him on a basis which is not more favorable than that on 
which they are furnished to the general public. Similarly, the sale of a 
book or magazine by a private foundation to disqualified persons shall 
not be an act of self-dealing if the publication of such book or 
magazine is functionally related to a charitable or educational activity 
of the foundation and the book or magazine is made available to the 
disqualified persons and the general public at the same price. In 
addition, if the terms of the sale require, for example, payment within 
60 days from the date of delivery of the book or magazine, such terms 
are consistent with normal commercial practices, and payment is made 
within the 60-day period, the transaction shall not be treated as a loan 
or other extension of credit under Sec. 53.4941(d)-2(c)(1).
    (c) Payment of compensation for certain personal services--(1) In 
general. Under section 4941(d)(2)(E), except in the case of a Government 
official (as defined in section 4946(c)), the payment of compensation 
(and the payment or reimbursement of expenses, including reasonable 
advances for expenses anticipated in the immediate future) by a private 
foundation to a disqualified person for the performance of personal 
services which are reasonable and necessary to carry out the exempt 
purpose of the private foundation shall not be an act of self-dealing if 
such compensation (or payment or reimbursement) is not excessive. For 
purposes of this subparagraph the term ``personal services'' includes 
the services of a broker serving as agent for the private foundation, 
but not the services of a dealer who buys from the private foundation as 
principal and resells to third parties. For the determination whether 
compensation is excessive, see Sec. 1.162-7 of this chapter (Income Tax 
Regulations). This paragraph applies without regard to whether the 
person who receives the compensation (or payment or reimbursement) is an 
individual. The portion of any payment which represents payment for 
property shall not be treated as payment of compensation (or payment or 
reimbursement of expenses) for the performance of personal services for 
purposes of this paragraph. For rules with respect to the performance of 
general banking services, see Sec. 53.4941(d)-2(c)(4). Further, the 
making of a cash advance to a foundation manager or employee for 
expenses on behalf of the foundation is not an act of self-dealing, so 
long as the amount of the advance is reasonable in relation to the 
duties and expense requirements of the foundation manager. Except where 
reasonably allowable pursuant to subdivision (iii) of this subparagraph, 
such advances shall not ordinarily exceed $500. For example, if a 
foundation makes an advance to a foundation manager to cover anticipated 
out-of-

[[Page 68]]

pocket current expenses for a reasonable period (such as a month) and 
the manager accounts to the foundation under a periodic reimbursement 
program for actual expenses incurred, the foundation will not be 
regarded as having engaged in an act of self-dealing:
    (i) When it makes the advance,
    (ii) When it replenishes the funds upon receipt of supporting 
vouchers from the foundation manager, or
    (iii) If it temporarily adds to the advance to cover extraordinary 
expenses anticipated to be incurred in fulfillment of a special 
assignment (such as long distance travel).
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a partnership, is a firm of 10 lawyers engaged in the 
practice of law. A and B, partners in M, serve as trustees to private 
foundation W and, therefore, are disqualified persons. In addition, A 
and B own more than 35 percent of the profits interest in M, thereby 
making M a disqualified person. M performs various legal services for W 
from time to time as such services are requested. The payment of 
compensation by W to M shall not constitute an act of self-dealing if 
the services performed are reasonable and necessary for the carrying out 
of W's exempt purposes and the amount paid by W for such services is not 
excessive.
    Example 2. C, a manager of private foundation X, owns an investment 
counseling business. Acting in his capacity as an investment counselor, 
C manages X's investment portfolio for which he receives an amount which 
is determined to be not excessive. The payment of such compensation to C 
shall not constitute an act of self-dealing.
    Example 3. M, a commercial bank, serves as a trustee for private 
foundation Y. In addition to M's duties as trustee, M maintains Y's 
checking and savings accounts and rents a safety deposit box to Y. The 
use of the funds by M and the payment of compensation by Y to M for such 
general banking services shall be treated as the payment of compensation 
for the performance of personal services which are reasonable and 
necessary to carry out the exempt purposes of Y if such compensation is 
not excessive.
    Example 4. D, a substantial contributor to private foundation Z, 
owns a factory which manufactures microscopes. D contracts with Z to 
manufacture 100 microscopes for Z. Any payment to D under the contract 
shall constitute an act of self-dealing, since such payment does not 
constitute the payment of compensation for the performance of personal 
services.

    (d) Certain transactions between a foundation and a corporation--(1) 
In general. Under section 4941(d)(2)(F), any transaction between a 
private foundation and a corporation which is a disqualified person will 
not be an act of self-dealing if such transaction is engaged in pursuant 
to a liquidation, merger, redemption, recapitalization, or other 
corporate adjustment, organization, or reorganization, so long as all 
the securities of the same class as that held (prior to such 
transaction) by the foundation are subject to the same terms and such 
terms provide for receipt by the foundation of no less than fair market 
value. For purposes of this paragraph, all of the securities are not 
``subject to the same terms unless, pursuant to such transaction,'' The 
corporation makes a bona fide offer on a uniform basis to the foundation 
and every other person who holds such securities. The fact that a 
private foundation receives property, such as debentures, while all 
other persons holding securities of the same class receive cash for 
their interests, will be evidence that such offer was not made on a 
uniform basis. This paragraph may apply even if no other person holds 
any securities of the class held by the foundation. In such event, 
however, the consideration received by holders of other classes of 
securities, or the interests retained by holders of such other classes, 
when considered in relation to the consideration received by the 
foundation, must indicate that the foundation received at least as 
favorable treatment in relation to its interests as the holders of any 
other class of securities. In addition, the foundation must receive no 
less than the fair market value of its interests.
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. Private foundation X owns 50 percent of the class A 
preferred stock of corporation M, which is a disqualified person with 
respect to X. The terms of such securities provide that the stock may be 
called for redemption at any time by M at 105 percent of the face amount 
of the stock. M exercises this right and calls all the class A preferred 
stock by paying 105 percent of the face amount in cash. At the time of 
the redemption of the class A preferred stock, it is determined that the 
fair market value of the

[[Page 69]]

preferred stock is equal to its face amount. In such case, the 
redemption by M of the preferred stock of X is not an act of self-
dealing.
    Example 2. Private foundation Y, which is on a calendar year basis, 
acquires 60 percent of the class A preferred stock of corporation N by 
will on January 10, 1970. N, which is also on a calendar year basis, is 
a disqualified person with respect to Y. In 1971, N offers to redeem all 
of the class A preferred stock for a consideration equal to 100 percent 
of the face amount of such stock by the issuance of debentures. The 
offer expires January 2, 1972. Both Y and all other holders of the class 
A preferred stock accept the offer and enter into the transaction on 
January 2, 1972, at which time it is determined that the fair market 
value of the debentures is no less than the fair market value of the 
preferred stock. The transaction on January 2, 1972, shall not be 
treated as an act of self-dealing for 1972. However, because under Sec. 
53.4941 (e)-1 (e)(1)(i) an act of self dealing occurs on the first day 
of each taxable year or portion of a taxable year that an extension of 
credit from a foundation to a disqualified person goes uncorrected, if 
such debentures are held by Y after December 31, 1972, except as 
provided in Sec. 53.4941(d)-4(c)(4), such extension of credit shall not 
be excepted from the definition of an act of self dealing by reason of 
the January 2, 1972, transaction. See Sec. 53.4941(d)-4(c)(4) for rules 
indicating that under certain circumstances such debentures could be 
held by Y until December 31, 1979.

    (e) Certain payments to government officials. Under section 
4941(d)(2)(G), in the case of a government official, in addition to the 
exceptions provided in section 4941(d)(2) (B), (C), and (D), section 
4941(d)(1) shall not apply to:
    (1) A prize or award which is not includible in gross income under 
section 74(b), if the government official receiving such prize or award 
is selected from the general public;
    (2) A scholarship or a fellowship grant which is excludable from 
gross income under section 117(a) and which is to be utilized for study 
at an educational institution described in section 151(e)(4);
    (3) Any annuity or other payment (forming part of a stock-bonus, 
pension, or profit sharing plan) by a trust which constitutes a 
qualified trust under section 401;
    (4) Any annuity or other payment under a plan which meets the 
requirements of section 404(a)(2);
    (5) Any contribution or gift (other than a contribution or gift of 
money) to, or services or facilities made available to, any government 
official, if the aggregate value of such contributions, gifts, services, 
and facilities does not exceed $25 during any calendar year;
    (6) Any payment made under 5 U.S.C. Chapter 41 (relating to 
government employees' training programs);
    (7) Any payment or reimbursement of traveling expenses (including 
amounts expended for meals and lodging, regardless of whether the 
government official is away from home within the meaning of section 
162(a)(2), and including reasonable advances for such expenses 
anticipated in the immediate future) for travel solely from one point in 
the United States to another in connection with one or more purposes 
described in section 170(c) (1) or (2)(B), but only if such payment or 
reimbursement does not exceed the actual cost of the transportation 
involved plus an amount for all other traveling expenses not in excess 
of 125 percent of the maximum amount payable under 5 U.S.C. 5702(a) for 
like travel by employees of the United States;
    (8) Any agreement to employ or make a grant to a government official 
for any period after the termination of his government service if such 
agreement is entered into within 90 days prior to such termination;
    (9) If a government official attends or participates in a conference 
sponsored by a private foundation, the allocable portion of the cost of 
such conference and other nonmonetary benefits (for example, benefits of 
a professional, intellectual, or psychological nature, or benefits 
resulting from the publication or the distribution to participants of a 
record of the conference), as well as the payment or reimbursement of 
expenses (including reasonable advances for expenses anticipated in 
connection with such a conference in the near future), received by such 
government official as a result of such attendance or participation 
shall not be subject to section 4941(d)(1), so long as the conference is 
in furtherance of the exempt purposes of the foundation; or
    (10) In the case of any government official who was on leave of 
absence without pay on December 31, 1969, pursuant to a commitment 
entered into on or before such date for the purpose of

[[Page 70]]

engaging in certain activities for which such individual was to be paid 
by one or more private foundations, any payment of compensation (or 
payment or reimbursement of expenses, including reasonable advances for 
expenses anticipated in the immediate future) by such private 
foundations to such individual for any continuous period after December 
31, 1969, and prior to January 1, 1971, during which such individual 
remains on leave of absence to engage in such activities. A commitment 
is considered entered into on or before December 31, 1969, if on or 
before such date, the amount and nature of the payments to be made and 
the name of the individual receiving such payments were entered on the 
records of the payor, or were otherwise adequately evidenced, or the 
notice of the payment to be received was communicated to the payee 
orally or in writing.

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7938, 49 FR 
3848, Jan. 31, 1984]



Sec. 53.4941(d)-4  Transitional rules.

    (a) Certain transactions involving securities acquired by a 
foundation before May 27, 1969--(1) In general. Under section 
101(l)(2)(A) of the Tax Reform Act of 1969 (83 Stat. 533), any 
transaction between a private foundation and a corporation which is a 
disqualified person shall not be an act of self-dealing if such 
transaction is pursuant to the terms of securities of such corporation, 
if such terms were in existence at the time such securities were 
acquired by the foundation, and if such securities were acquired by the 
foundation before May 27, 1969.
    (2) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. Private foundation X purchased preferred stock of 
corporation M, a disqualified person with respect to X, on March 15, 
1969. The terms of such securities on such date provided that the stock 
could be called by M at any time if M paid the outstanding shareholders 
cash equal to 105 percent of the face amount of the stock. If M 
exercises this right and calls the stock owned by X on February 15, 
1970, such call shall not constitute an act of self-dealing even if such 
price is not equivalent to fair market value on such date and even if 
not all of the securities of that class are called.

    (b) Disposition of certain business holdings--(1) In general. Under 
section 101(l)(2)(B) of the Tax Reform Act of 1969 (83 Stat. 533), the 
sale, exchange, or other disposition of property which is owned by a 
private foundation on May 26, 1969, to a disqualified person shall not 
be an act of self-dealing if the foundation is required to dispose of 
such property in order not to be liable for tax under section 4943 
(determined without regard to section 4943(c)(2)(C) and as if every 
disposition by the foundation were made to disqualified persons) and if 
such disposition satisfies the requirements of subparagraph (2) of this 
paragraph. For purposes of applying this paragraph in the case of a 
disposition completed before January 1, 1975, or after October 4, 1976, 
and before January 1, 1977, the amount of excess business holdings is 
determined under section 4943(c) without taking subsection (c)(4) into 
account.
    (2) Terms of the disposition. Subparagraph (1) of this paragraph 
shall not apply unless:
    (i) The private foundation receives an amount which equals or 
exceeds the fair market value of the business holdings at the time of 
disposition or at the time a contract for such disposition was 
previously executed; and
    (ii) At the time with respect to which subdivision (i) of this 
subparagraph is applied, the transaction would not have constituted a 
prohibited transaction within the meaning of section 503(b) or the 
corresponding provisions of prior law if such provisions had been 
applied at such time.
    (3) Property received under a trust or will. For purposes of this 
paragraph, property shall be considered as owned by a private foundation 
on May 26, 1969, if such property is acquired by such foundation under 
the terms of a will executed on or before such date, under the terms of 
a trust which was irrevocable on such date, or under the terms of a 
revocable trust executed on or before such date if the property would 
have passed under a will which would have met the requirements of this 
subparagraph but for the fact that a grantor dies without having revoked 
the trust. An amendment or republication of a will which was executed on 
or before May 26, 1969, does not prevent any

[[Page 71]]

interest in a business enterprise which was to pass under the terms of 
such will (which terms were in effect on May 26, 1969, and at all times 
thereafter) from being treated as owned by a private foundation on or 
before May 26, 1969, solely because:
    (i) There is a reduction in the interest in the business enterprise 
which the foundation was to receive under the terms of the will (for 
example, if the foundation is to receive the residuary estate and one 
class of stock is disposed of by the decedent during his lifetime or by 
a subsequent codicil),
    (ii) Such amendment or republication is necessary in order to comply 
with section 508(e) and the regulations thereunder,
    (iii) There is a change in the executor of the will, or
    (iv) There is any other change which does not otherwise change the 
rights of the foundation with respect to such interest in the business 
enterprise.

However, if under such amendment or republication there is an increase 
of the interest in the business enterprise which the foundation was to 
receive under the terms of the will in effect on May 26, 1969, such 
increase shall not be treated as owned by the private foundation on or 
before May 26, 1969, but under such circumstances the interest which 
would have been acquired before such increase shall be treated as owned 
by the private foundation on or before May 26, 1969.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. On May 26, 1969, private foundation X owns 10 percent of 
corporation Y's voting stock, which is traded on the New York Stock 
Exchange. Disqualified persons with respect to X own an additional 40 
percent of such voting stock. X is on a calendar year basis. Prior to 
January 1, 1975, X privately sold its entire 10 percent for cash to B, a 
disqualified person, at the price quoted on the stock exchange at the 
close of the day less commissions. Since the 10 percent owned by X would 
constitute excess business holdings without the application of section 
4943(c) (2)(C) or (4), the disposition will not constitute an act of 
self-dealing.
    Example 2. Assume the facts as stated in example (1), except that 
the only stock of corporation Y which X owns is 1.5 percent of Y's 
voting stock. Since the 1.5 percent owned by X would constitute excess 
business holdings without the application of section 4943(c) (2)(C) or 
(4), the disposition of the stock to B for cash will not constitute an 
act of self-dealing.
    Example 3. Assume the facts as stated in example (1), except that B, 
instead of paying cash as consideration for the stock, issued a 10-year 
secured promissory note as consideration for the stock. The issuance of 
such promissory note will not be treated as an act of self-dealing until 
taxable years beginning after December 31, 1979, unless such issuance 
would have been a prohibited transaction under section 503(b), or unless 
the transaction does not remain throughout its life at least as 
favorable as an arm's-length contract negotiated currently. See 
paragraph (c) of this section.

    (c) Existing leases and loans--(1) In general. Under section 
101(1)(2)(C) of the Tax Reform Act of 1969 (83 Stat. 533), the leasing 
of property or the lending of money (or other extension of credit) 
between a disqualified person and a private foundation pursuant to a 
binding contract which was in effect on October 9, 1969 (or pursuant to 
a renewal or modification of such a contract, as described in 
subparagraph (2) of this paragraph), shall not be an act of self-dealing 
until taxable years beginning after December 31, 1979, if:
    (i) At the time the contract was executed, such contract was not a 
prohibited transaction (within the meaning of section 503(b) or the 
corresponding provisions of prior law), and
    (ii) The leasing or lending of money (or other extension of credit) 
remains throughout the term of the lease or extension of credit at least 
as favorable as a current arm's-length transaction with an unrelated 
person.
    (2) Renewal or modification of existing contracts. A renewal or a 
modification of an existing contract is referred to in subparagraph (1) 
of this paragraph only if any modifications of the terms of such 
contract are not substantial and the relative advantages of the modified 
contract compared with contracts entered into at arm's-length with an 
unrelated person at the time of the renewal or modification are at least 
as favorable to the private foundation as the relative advantages of the 
original contract compared with contracts entered into at arm's-length 
with an unrelated person at the time of execution of the original 
contract. Such renewal or modification need not be provided

[[Page 72]]

for in the original contract; it may take place before or after the 
expiration of the original contract and at any time before the first day 
of the first taxable year of the private foundation beginning after 
December 31, 1979. Where, in a normal commercial setting, an unrelated 
party in the position of a private foundation could be expected to 
insist upon a renegotiation or termination of a binding contract, the 
private foundation must so act. Thus, for example, if a disqualified 
person leases office space from a private foundation on a month-to-month 
basis, and a party in the position of the private foundation could be 
expected to renegotiate the rent required in such contract because of a 
rise in the fair market value of such office space, the private 
foundation must so act in order to avoid participation in an act of 
self-dealing. Where the private foundation has no right to insist upon 
renegotiation, an act of self-dealing shall occur if the terms of the 
contract become less favorable to the foundation than an arm's-length 
contract negotiated currently, unless:
    (i) The variation from current fair market value is de minimis, or
    (ii) The contract is renegotiated by the foundation and the 
disqualified person so that the foundation will receive no less than 
fair market value. For purposes of subdivision (i) of this subparagraph 
de minimis ordinarily shall be no more than one-half of 1 percent in the 
rate of return in the case of a loan, or 10 percent of the rent in the 
case of a lease.
    (3) Example. The provisions of subparagraphs (1) and (2) of this 
paragraph may be illustrated by the following example.

    Example. Under a binding contract entered into on January 1, 1964, 
X, a private foundation, leases a building for 10 years from Z, a 
disqualified person. At the time the contract was executed, the lease 
was not a ``prohibited transaction'' within the meaning of section 
503(b), since the rent charged X was only 50 percent of the rent which 
would have been charged in an arm's-length transaction with an unrelated 
person. On January 1, 1974, X renewed the lease for 5 additional years. 
The terms of the renewal agreement provided for a 20 percent increase in 
the amount of rent charged X. However, at the time of such renewal, the 
rent which would have been charged in an arm's-length transaction had 
also increased by 20 percent from that of 1964. The renewal agreement 
shall not be treated as an act of self-dealing.

    (4) Certain exchanges of stock or securities for bonds, debentures 
or other indebtedness. (i) In the case of a transaction described in 
paragraph (a) or (b) of this section or paragraph (d) of Sec. 
53.4941(d)-3, where a bond, debenture, or other indebtedness of a 
disqualified person is acquired by a private foundation in exchange for 
stock or securities which it held on October 9, 1969, and at all times 
thereafter, such indebtedness shall be treated as an extension of credit 
pursuant to a binding contract in effect on October 9, 1969, to which 
this paragraph applies. Thus, so long as the extension of credit remains 
at least as favorable as an arm's-length transaction with an unrelated 
person and neither the acquisition of the securities which were 
exchanged for the indebtedness nor the exchange of such securities for 
the indebtedness was a prohibited transaction within the meaning of 
section 503(b) (or the corresponding provisions of prior law) at the 
time of such acquisition, such extension of credit shall not be an act 
of self-dealing until taxable years beginning after December 31, 1979.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. Assume the facts as stated in example (2) of Sec. 
53.4941 (d)-3 (d)(2), except that the preferred stock was held by Y on 
October 9, 1969, and at all times thereafter until the redemption 
occurred on January 2, 1972. In addition, assume that the acquisition of 
the preferred stock was not a prohibited transaction within the meaning 
of section 503(b) at the time of such acquisition and the exchange of 
the preferred stock for the debentures would not have been a prohibited 
transaction within the meaning of section 503(b). For 1973 through 1979, 
the extension of credit arising from the holding of the debentures is 
not an act of self-dealing so long as the extension of credit remains at 
least as favorable as an arm's-length transaction with an unrelated 
person. See, however, example (3) of Sec. 53.4941 (e)-1 (e)(1)(ii).
    Example 2. Assume the same facts as stated in example (1) of Sec. 
53.4941 (d)-4 (b)(4), except that private foundation X sold its entire 
10 percent of corporation Y's voting stock in exchange for Y's secured 
notes which mature on December 31, 1985. For taxable years beginning 
before January 1, 1980, the extension

[[Page 73]]

of credit arising from the holding of such notes by X is not an act of 
self-dealing so long as the extension of credit remains at least as 
favorable as an arm's-length transaction with an unrelated person and 
neither the acquisition of the securities which were exchanged for the 
indebtedness nor the exchange of such securities for the indebtedness 
was a prohibited transaction within the meaning of section 503(b) (or 
the corresponding provisions of prior law). Under Sec. 53.4941(e)-1, a 
new extension of credit occurs on the first day of each taxable year in 
which an indebtedness is outstanding; therefore, if the secured notes 
are held by X after December 31, 1979, a new extension of credit not 
excepted from the definition of an act of self-dealing will occur on the 
first day of the first taxable year beginning after December 31, 1979, 
and on the first day of each succeeding taxable year in which X holds 
such secured notes.

    (d) Sharing of goods, services, or facilities before January 1, 
1980. (1) Under section 101(1)(2)(D) of the Tax Reform Act of 1969 (83 
Stat. 533), the use (other than leasing) of goods, services, or 
facilities which are shared by a private foundation and a disqualified 
person shall not be an act of self-dealing until taxable years beginning 
after December 31, 1979, if:
    (i) The use is pursuant to an arrangement in effect before October 
9, 1969, and at all times thereafter;
    (ii) The arrangement was not a prohibited transaction (within the 
meaning of sec. 503(b) or the corresponding provisions of prior law) at 
the time it was made; and
    (iii) The arrangement would not be a prohibited transaction if 
section 503(b) continued to apply.

For purposes of this paragraph, such arrangement need not be a binding 
contract.
    (2) The provisions of this paragraph may be illustrated by the 
following example:

    Example. In 1964 X, a private foundation, and B, a disqualified 
person, arranged for the sharing of computer time in B's son's company 
for a 10-year period commencing January 1, 1965. B's son has the 
unilateral right to terminate the arrangement at any time. X uses the 
computer facilities in connection with an analysis of its grant-making 
activities, while B's use is related to his business affairs. Both X and 
B make reasonable fixed payments to the computer company based on the 
number of hours of computer use and comparable to fees charged in arm's-
length transactions with unrelated parties. The company imposes a 
maximum limit per month on the sum of the number of hours for which X 
and B use the computer facilities. Under these circumstances, the 
sharing of computer time is not an act of self-dealing.

    (e) Use of certain property acquired before October 9, 1969. (1) 
Under section 101(1)(2)(E) of the Tax Reform Act of 1969 (83 Stat. 533), 
the use of property in which a private foundation and a disqualified 
person have a joint or common interest will not be an act of self-
dealing if the interests of both in such property were acquired before 
October 9, 1969.
    (2) The provisions of this paragraph may be illustrated by the 
following example:

    Example. Prior to October 9, 1969, C, a disqualified person, gave 
beachfront property to private foundation X for use as a recreational 
facility for underprivileged, inner-city children during the summer 
months. However, C retained the right to use such property for his life. 
The use of such property by C or X is not an act of self-dealing.

    (f) Disposition of leased property--(1) In general. Under section 
101(l)(2)(F) of the Tax Reform Act of 1969, as amended by the Tax Reform 
Act of 1976 (90 Stat. 1713), the sale, exchange or other disposition 
(other than by lease) to a disqualified person of property being leased 
to the disqualified person by a private foundation is not an act of 
self-dealing if:
    (i) The private foundation is leasing substantially all of the 
property to the disqualified person under a lease to which paragraph (c) 
of this section applies;
    (ii) The disposition occurs after October 4, 1976, and before 
January 1, 1978; and
    (iii) The disposition satisfies the requirements of paragraph (f)(2) 
of this section.
    (2) Terms of disposition. Paragraph (f)(1) of this section applies 
only if:
    (i) The private foundation receives an amount that equals or exceeds 
the fair market value of the property either at the time of the 
disposition or at the time (after June 30, 1976) the contract for such 
disposition was executed;
    (ii) In computing the fair market value of the property, no 
diminution of that value results from the fact that

[[Page 74]]

the property is subject to any lease to disqualified persons; and
    (iii) At the time with respect to which paragraph (f)(2)(i) of this 
section is applied, the transaction would not have constituted a 
prohibited transaction within the meaning of section 503(b) or the 
corresponding provisions of prior law if those provisions had been 
applied at the time of the transaction.

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7678, 45 FR 
12416, Feb. 26, 1980]



Sec. 53.4941(e)-1  Definitions.

    (a) Taxable period--(1) In general. For purposes of any act of self-
dealing, the term ``taxable period'' means the period beginning with the 
date on which the act of self-dealing occurs and ending on the earliest 
of:
    (i) The date of mailing of a notice of deficiency under section 6212 
with respect to the tax imposed by section 4941(a)(1),
    (ii) The date on which correction of the act of self-dealing is 
completed, or
    (iii) The date on which the tax imposed by section 4941(a)(1) is 
assessed.
    (2) Date of occurrence. An act of self-dealing occurs on the date on 
which all the terms and conditions of the transaction and the 
liabilities of the parties have been fixed. Thus, for example, if a 
private foundation gives a disqualified person a binding option on June 
15, 1971, to purchase property owned by the foundation at any time 
before June 15, 1972, the act of self-dealing has occurred on June 15, 
1971. Similarly, in the case of a conditional sales contract, the act of 
self-dealing shall be considered as occurring on the date the property 
is transferred subject only to the condition that the buyer make payment 
for receipt of such property.
    (3) Special rule. Where a notice of deficiency referred to in 
subparagraph (1)(i) of this paragraph is not mailed because a waiver of 
the restrictions on assessment and collection of a deficiency has been 
accepted, or because the deficiency is paid, the date of filing of the 
waiver or the date of such payment, respectively, shall be treated as 
the end of the taxable period.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. On July 16, 1970, F, a manager of private foundation X 
acting on behalf of the foundation, knowing his act to be one of self-
dealing, willfully and without reasonable cause engaged in an act of 
self-dealing by selling certain real estate to A, a disqualified person. 
On March 25, 1973, the Internal Revenue Service mailed a notice of 
deficiency to A with respect to the tax imposed on the sale under 
section 4941(a)(1). The taxable period with respect to the act of self-
dealing for both A and F is July 16, 1970, through March 25, 1973.
    Example 2. Assume the facts as stated in example (1), except that 
the act of self-dealing is corrected by A on March 17, 1971. The taxable 
period with respect to the act of self-dealing for both A and F is July 
16, 1970, through March 17, 1971.
    Example 3. Assume the facts as stated in example (1), except that on 
August 20, 1972, A files a waiver of the restrictions on assessment and 
collection of the tax imposed on the sale under section 4941(a)(1) which 
is accepted. The taxable period with respect to the act of self-dealing 
for both A and F is July 16, 1970, through August 20, 1972.

    (b) Amount involved--(1) In general. Except as provided in 
subparagraph (2) of this paragraph, for purposes of any act of self-
dealing, the term ``amount involved'' means the greater of the amount of 
money and the fair market value of the other property given or the 
amount of money and the fair market value of the other property 
received.
    (2) Exceptions. (i) In the case of the payment of compensation for 
personal services to persons other than Government officials, the amount 
involved shall be only the excess compensation paid by the private 
foundation.
    (ii) Where the use of money or other property is involved, the 
amount involved shall be the greater of the amount paid for such use or 
the fair market value of such use for the period for which the money or 
other property is used. Thus, for example, in the case of a lease of a 
building by a private foundation to a disqualified person, the amount 
involved is the greater of the amount of rent received by the private 
foundation from the disqualified person or the fair rental value of the 
building for the period such building is used by the disqualified 
person.
    (iii) In cases in which a transaction would not have been an act of 
self-dealing had the private foundation received fair market value, the 
amount involved

[[Page 75]]

is the excess of the fair market value of the property transferred by 
the private foundation over the amount which the private foundation 
receives, but only if the parties have made a good faith effort to 
determine fair market value. For purposes of this subdivision a good 
faith effort to determine fair market value shall ordinarily have been 
made where:
    (a) The person making the valuation is not a disqualified person 
with respect to the foundation and is both competent to make the 
valuation and not in a position, whether by stock ownership or 
otherwise, to derive an economic benefit from the value utilized, and
    (b) The method utilized in making the valuation is a generally 
accepted method for valuing comparable property, stock, or securities 
for purposes of arm's-length business transactions where valuation is a 
significant factor.


See section 4941(d)(2)(F) and Sec. Sec. 53.4941(d)-1(b)(3), 53.4941(d)-
3 (d)(1) and 53.4941(d)-4(b). Thus, for example, if a corporation which 
is a disqualified person with respect to a private foundation 
recapitalizes in a transaction which would be described in section 
4941(d)(2)(F) but for the fact that the private foundation receives new 
stock worth only $95,000 in exchange for the stock which it previously 
held in the corporation and which has a fair market value of $100,000 at 
the time of the recapitalization, the amount involved would be $5,000 
($100,000--$95,000) if there had been a good faith attempt to value the 
stock. Similarly, if an estate enters into a transaction with a 
disqualified person with respect to a foundation and such transaction 
would be described in Sec. 53.4941(d)-1(b)(3) but for the fact that the 
estate receives less than fair market value for the property exchanged, 
the amount involved is the excess of the fair market value of the 
property the estate transfers to the disqualified person over the money 
and the fair market value of the property received by the estate.
    (3) Time for determining fair market value. The fair market value of 
the property or the use thereof, as the case may be, shall be determined 
as of the date on which the act of self-dealing occurred in the case of 
the initial taxes imposed by section 4941(a) and shall be the highest 
fair market value during the taxable period in the case of the 
additional taxes imposed by section 4941(b).
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. A, a disqualified person with respect to private 
foundation M, uses an airplane owned by M on June 15 and June 16, 1970, 
for a 2-day trip to New York City on personal business and pays M $500 
for the use of such airplane. The fair rental value for the use of the 
airplane for those 2 days is $3,000. For purposes of section 4941(a), 
the amount involved with respect to the act of self-dealing is $3,000.
    Example 2. On April 10, 1970, B, a manager of private foundation P, 
borrows $100,000 from P at 6 percent interest per annum. Both principal 
and interest are to be paid 1 year from the date of the loan. The fair 
market value of the use of the money on April 10, 1970, is 10 percent 
per annum. Six months later, B and P terminate the loan, and B repays 
the $100,000 principal plus $3,000 ($100,000x6 percent for one-half 
year) interest. For purposes of section 4941(a), the amount involved 
with respect to the act of self-dealing is $5,000 ($100,000x10 percent 
for one-half year) for each year or partial year in the taxable period.
    Example 3. C, a substantial contributor to private foundation S, 
leases office space in a building owned by S for $3,600 for 1 year 
beginning on January 1, 1971. The fair rental value of the building for 
a 1-year lease on January 1, 1971, is $5,600. On December 31, 1971, the 
lease is terminated. For purposes of section 4941(a), the amount 
involved with respect to the act of self-dealing is $5,600 for each year 
or partial year in the taxable period.
    Example 4. D, a disqualified person with respect to private 
foundation T, purchases 100 shares of stock from T for $5,000 on June 
15, 1982. The fair market value of the 100 shares of stock on that date 
is $4,800. D sells the 100 shares of stock on December 20, 1983, for 
$6,000. On December 27, 1983, a notice of deficiency with respect to the 
taxes imposed under subsections (a) and (b) of section 4941 is mailed to 
D and the taxable period ends. D fails to correct during the taxable 
period. Between June 15, 1982, and the end of the taxable period, the 
stock was quoted on the New York Stock Exchange at a high of $67 per 
share. The amount involved with respect to the tax imposed under 
subsection (a) is $5,000, and the amount involved with respect to the 
tax imposed under subsection (b) for failure to correct is $6,700 (100 
shares at $67 per share), the highest fair market value during the 
taxable period.

[[Page 76]]

    Example 5. Corporation M, a disqualified person with respect to 
private foundation V, redeems all of its Class B common stock, some of 
which is held by V. The redemption of V's stock would be described in 
section 4941(d)(2)(F) but for the fact that V receives only $95,000 in 
exchange for stock which has a fair market value of $100,000 at the time 
of the transaction. The $95,000 value of V's stock, which is not 
publicly traded, was determined by investment bankers in accordance with 
accepted methods of valuation that would be utilized if the M stock held 
by V were to be offered for sale to the public. Therefore, the amount 
involved with respect to the transaction will ordinarily be limited to 
$5,000 ($100,000--$95,000).

    (c) Correction--(1) In general. Correction shall be accomplished by 
undoing the transaction which constituted the act of self-dealing to the 
extent possible, but in no case shall the resulting financial position 
of the private foundation be worse than that which it would be if the 
disqualified person were dealing under the highest fiduciary standards. 
For example, where a disqualified person sells property to a private 
foundation for cash, correction may be accomplished by recasting the 
transaction in the form of a gift by returning the cash to the 
foundation. Subparagraphs (2) through (6) of this paragraph illustrate 
the minimum standards of correction in the case of certain specific acts 
of self-dealing. Principles similar to the principles contained in such 
subparagraphs shall be applied with respect to other acts of self-
dealing. Any correction pursuant to this paragraph and section 4941 
shall not be an act of self-dealing.
    (2) Sales by foundation. (i) In the case of a sale of property by a 
private foundation to a disqualified person for cash, undoing the 
transaction includes, but is not limited to, requiring recission of the 
sale where possible. However, in order to avoid placing the foundation 
in a position worse than that in which it would be if rescission were 
not required, the amount returned to the disqualified person pursuant to 
the rescission shall not exceed the lesser of the cash received by the 
private foundation or the fair market value of the property received by 
the disqualified person. For purposes of the preceding sentence, fair 
market value shall be the lesser of the fair market value at the time of 
the act of self-dealing or the fair market value at the time of 
rescission. In addition to rescission, the disqualified person is 
required to pay over to the private foundation any net profits he 
realized after the original sale with respect to the property he 
received from the sale. Thus, for example, the disqualified person must 
pay over to the foundation any income derived by him from the property 
he received from the original sale to the extent such income during the 
correction period exceeds the income derived by the foundation during 
the correction period from the cash which the disqualified person 
originally paid to the foundation.
    (ii) If, prior to the end of the correction period, the disqualified 
person resells the property in an arm's-length transaction to a bona 
fide purchaser who is not the foundation or another disqualified person, 
no rescission is required. In such case, the disqualified person must 
pay over to the foundation the excess (if any) of the greater of the 
fair market value of such property on the date on which correction of 
the act of self-dealing occurs or the amount realized by the 
disqualified person from such arm's length resale over the amount which 
would have been returned to the disqualified person pursuant to 
subdivision (i) of this subparagraph if rescission had been required. In 
addition, the disqualified person is required to pay over to the 
foundation any net profits he realized, as described in subdivision (i) 
of this subparagraph.
    (iii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. On July 1, 1970, private foundation M sold a painting to 
A, a disqualified person, for $5,000, in a transaction not within any of 
the exceptions to self-dealing. The fair market value of the painting on 
such date was $6,000. On March 25, 1971, the painting is still owned by 
A and has a fair market value of $7,200. A did not derive any income as 
a result of purchasing the painting. In order to correct the act of 
self-dealing under this subparagraph on March 25, 1971, the sale must be 
rescinded by the return of the painting to M. However, pursuant to such 
rescission, M must not pay A more than $5,000, the original 
consideration received by M.
    Example 2. Assume the facts as stated in Example (1), except that A 
sold the painting on December 15, 1970, in an arm's-length transaction 
to C, a bona fide purchaser who

[[Page 77]]

is not a disqualified person, for $6,100. In addition, assume that the 
fair market value of the painting on March 25, 1971, is $7,600. In order 
to correct the act of self-dealing under this subparagraph on March 25, 
1971, A must pay M $2,600 ($7,600, the fair market value at the time of 
correction, less $5,000, the amount which would have been returned to A 
if rescission had been required). Since the painting was sold to C in an 
arm's-length transaction prior to correction, no rescission is required.

    (3) Sales to foundation. (i) In the case of a sale of property to a 
private foundation by a disqualified person for cash, undoing the 
transaction includes, but is not limited to, requiring rescission of the 
sale where possible. However, in order to avoid placing the foundation 
in a position worse than that in which it would be if rescission were 
not required, the amount received from the disqualified person pursuant 
to the rescission shall be the greatest of the cash paid to the 
disqualified person, the fair market value of the property at the time 
of the original sale, or the fair market value of the property at the 
time of rescission. In addition to rescission, the disqualified person 
is required to pay over to the private foundation any net profits he 
realized after the original sale with respect to the consideration he 
received from the sale. Thus, for example, the disqualified person must 
pay over to the foundation any income derived by him from the cash he 
received from the original sale to the extent such income during the 
correction period exceeds the income derived by the foundation during 
the correction period from the property which the disqualified person 
originally transferred to the foundation.
    (ii) If, prior to the end of the correction period, the foundation 
resells the property in an arm's-length transaction to a bona fide 
purchaser who is not a disqualified person, no rescission is required. 
In such case, the disqualified person must pay over to the foundation 
the excess (if any) of the amount which would have been received from 
the disqualified person pursuant to subdivision (i) of this 
subparagraph, if recission had been required over the amount realized by 
the foundation upon resale of the property. In addition, the 
disqualified person is required to pay over to the foundation any net 
profits he realized, as described in subdivision (i) of this 
subparagraph.
    (iii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. On February 10, 1972, D, a disqualified person with 
respect to private foundation P, sells 100 shares of X stock to P for 
$2,500 in a transaction which does not fall within any of the exceptions 
to selfdealing. The fair market value of the 100 shares of X stock on 
February 10, 1972, is $3,200. On June 1, 1973, the 100 shares of X stock 
have a fair market value of $2,900. From February 10, 1972, through June 
1, 1973, P has received dividends of $90 from the stock, and D has 
received interest of $300 from the $2,500 which D received as 
consideration for the stock. In order to correct the act of self-dealing 
under this subparagraph on June 1, 1973, the sale must be rescinded by 
the return of the stock to D. However, pursuant to such rescission, D 
must pay P $3,200, the fair market value of the stock on the date of 
sale. In addition, D must pay P $210, the amount of income derived by D 
during the correction period from the $2,500 received from P ($300) 
minus the income derived by P during the correction period from the 
stock sold to P ($90).
    Example 2. Assume the facts as stated in Example (1), except that on 
September 1, 1972, P sells the 100 shares of X stock to E, a bona fide 
purchaser who is not a disqualified person, in an arm's-length 
transaction for $2,750. Assume further that P has not received any 
dividends from the stock prior to the sale to E, but that P receives 
interest of $260 from the $2,750 received as consideration for the stock 
for the period from September 1, 1972, to June 1, 1973. In order to 
correct the act of self-dealing under this subparagraph on June 1, 1973, 
D must pay P $450 ($3,200, the amount which would have been received 
from D if rescission had been required, less $2,750, the amount realized 
by P from the sale to E). In addition, D must pay P $40, the amount of 
income derived by D during the correction period from the $2,500 
received from P ($300) minus the income derived by P during the 
correction period from the stock sold to P ($260 from the $2,750 
received as consideration for the stock). Since the stock was sold to E 
in an arm's-length transaction prior to correction, no rescission is 
required.

    (4) Use of property by a disqualified person. (i) In the case of the 
use by a disqualified person of property owned by a private foundation, 
undoing the transaction includes, but is not limited to, terminating the 
use of such property. In addition to termination, the disqualified 
person must pay the foundation:

[[Page 78]]

    (a) The excess (if any) of the fair market value of the use of the 
property over the amount paid by the disqualified person for such use 
until such termination, and
    (b) The excess (if any) of the amount which would have been paid by 
the disqualified person for the use of the property on or after the date 
of such termination, for the period such disqualified person would have 
used the property (without regard to any further extensions or renewals 
of such period) if such termination had not occurred, over the fair 
market value of such use for such period.

In applying (a) of this subdivision the fair market value of the use of 
property shall be the higher of the rate (that is, fair rental value per 
period in the case of use of property other than money or fair interest 
rate in the case of use of money) at the time of the act of self-dealing 
(within the meaning of paragraph (e)(1) of this section) or such rate at 
the time of correction of such act of self-dealing. In applying (b) of 
this subdivision the fair market value of the use of property shall be 
the rate at the time of correction.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. On January 1, 1972, private foundation S rented the third 
story of its office building to A, a disqualified person, for 1 year at 
an annual rent of $10,000, in a transaction not within any of the 
exceptions to self-dealing. Both S and A are on the calendar year basis. 
The fair rental value of such office space for a 1-year period on 
January 1, 1972, is $12,000. On June 30, 1972, the fair rental value of 
such office space for a 1-year period is $13,000. In order to correct 
the act of self-dealing under this subparagraph on June 30, 1972, A must 
terminate his use of the property. In addition, A must pay S $1,500, the 
excess of $6,500 (the fair rental value for 6 months as of June 30, 
1972) over $5,000 (the amount paid to S from Jan. 1, 1972, to June 30, 
1972).
    Example 2. On January 1, 1972, private foundation R rented the 
fourth story of its office building to B, a disqualified person, for 1 
year at an annual rent of $10,000, in a transaction not included in any 
of the exceptions to self-dealing. Both R and B are on the calendar year 
basis. On January 1, 1973, B continues to rent the office space as a 
periodic tenant paying his rent monthly at an annual rate of $10,000. 
The fair rental value of such office space for a 1-year period on 
January 1, 1972, is $12,000, and as of January 1, 1973, is $1,250 per 
month. As of December 31, 1973, the fair rental value of such office 
space is $14,000 for a 1-year period and $1,200 on a monthly basis. In 
order to correct his acts of self-dealing (within the meaning of 
paragraph (e)(1) of this section) under this subparagraph on December 
31, 1973, B must terminate his use of the property. In addition, B must 
pay R $9,000, $4,000 for his use of the property for 1972 (the excess of 
$14,000, the fair rental value for 1 year as of Dec. 31, 1973, over 
$10,000, the amount B paid R for his use of the property for 1972) and 
$5,000 for his use of the property for 1973 (the excess of $15,000, the 
fair rental value for 12 months as of Jan. 1, 1973, over $10,000, the 
amount B paid R for his use of the property for 1973).
    Example 3. B, a substantial contributor to private foundation T, 
leases office space in a building owned by T for $5,000 for 1 year 
beginning on November 10, 1972, in a transaction not included in any of 
the exceptions to self-dealing. The fair rental value of the building 
for a 1-year period on November 10, 1972, is $4,000. On May 10, 1973, 
the fair rental value of the building for the remaining period of the 
lease is $2,200. In order to correct the acts of self-dealing under this 
subparagraph on May 10, 1973, B and T must terminate the lease. In 
addition, B must pay T $300 (the excess of $2,500, the amount which 
would have been paid by B for the remaining period of the lease if it 
had not been terminated, over $2,200, the fair rental value at the time 
of correction for the remaining period of the lease).

    (5) Use of property by a private foundation. (i) In the case of the 
use by a private foundation of property owned by a disqualified person, 
undoing the transaction includes, but is not limited to, terminating the 
use of such property. In addition to termination, the disqualified 
person must pay the foundation:
    (a) The excess (if any) of the amount paid to the disqualified 
person for such use until such termination over the fair market value of 
the use of the property, and
    (b) The excess (if any) of the fair market value of the use of the 
property, for the period the foundation would have used the property 
(without regard to any further extensions or renewals of such period) if 
such termination had not occurred, over the amount which would have been 
paid to the disqualified person on or after the date of such termination 
for such use for such period.

[[Page 79]]


In applying (a) of this subdivision the fair market value of the use of 
property shall be the lesser of the rate (that is, fair rental value per 
period in the case of use of property other than money or fair interest 
rate in the case of use of money) at the time of the act of self-dealing 
(within the meaning of paragraph (e)(1) of this section) or such rate at 
the time of correction of such act of self-dealing. In applying (b) of 
this subdivision the fair market value of the use of property shall be 
the rate at the time of correction.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. On July 1, 1972, private foundation X leases office space 
in a building owned by C, a disqualified person, for 1 year at an annual 
rent of $6,000. Both X and C are on the calendar year basis. The fair 
rental value of such office space for a 1-year period as of July 1, 
1972, is $4,200. As of January 1, 1973, the fair rental value of such 
office space for a 1-year period is $5,400, and as of June 30, 1973, the 
fair rental value of such office space for a 1-year period is $4,800. In 
order to correct his acts of self-dealing (within the meaning of 
paragraph (e)(1) of this section) under this subparagraph on June 30, 
1973, C must terminate X's use of the property. In addition, C must pay 
X $1,500, $900 (the excess of $3,000, the amount paid to C from July 1, 
1972, through December 31, 1972, over $2,100, the fair rental value for 
6 months as of July 1, 1972) plus $600 (the excess of $3,000, the amount 
paid to C from January 1, 1973, through June 30, 1973, over $2,400, the 
fair rental value for 6 months as of June 30, 1973).
    Example 2. On April 1, 1973, D, a disqualified person with respect 
to private foundation Y, loans $100,000 to Y at 6 percent interest per 
annum. Both principal and interest are to be paid on April 1, 1978. The 
fair market value of the use of the money on April 1, 1973, is 9 percent 
per annum. On April 1, 1974, D and Y terminate the loan. On such date, 
the fair market value of the use of $100,000 is 10 percent per annum. In 
order to correct the act of self-dealing on April 1, 1974, in addition 
to the termination of the loan from D to Y, D must pay Y $16,000, the 
excess of $40,000 ($100,000x10 percent, the fair market value of the use 
determined at the time of correction, from April 1, 1974, to April 1, 
1978) over $24,000 (the amount of interest Y would have paid to D from 
April 1, 1974, to April 1, 1978, if the loan from D to Y had not been 
terminated).

    (6) Payment of compensation to a disqualified person. In the case of 
the payment of compensation by a private foundation to a disqualified 
person for the performance of personal services which are reasonable and 
necessary to carry out the exempt purpose of such foundation, undoing 
the transaction requires that the disqualified person pay to the 
foundation any amount which is excessive. However, termination of the 
employment or independent contractor relationship is not required.
    (7) Special rule for correction of valuation errors. (i) In the case 
of a transaction described in paragraph (b)(2)(iii) of this section, a 
``correction'' of the act of self-dealing shall ordinarily be deemed to 
occur if the foundation is paid an amount of money equal to the amount 
involved (as defined in paragraph (b)(2)(iii) of this section) plus such 
additional amounts as are necessary to compensate it for the loss of the 
use of the money or other property during the period commencing on the 
date of the act of self-dealing and ending on the date the transaction 
is corrected pursuant to this subparagraph.
    (ii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. Assume the same facts as in example (5) of paragraph (b)(4) 
of this section. Such transaction shall be considered as corrected by a 
payment of $5,000 by M to V, together with an additional payment to V of 
an amount equal to the interest which V could have obtained on $5,000 
for the period commencing on the date of the redemption and ending on 
the date the act is corrected.

    (d) Cross reference. For rules relating to taxable events that are 
corrected within the correction period, defined in section 4963 (e), see 
section 4961 (a), and the regulations thereunder.
    (e) Act of self-dealing--(1) Number of acts; use of money or 
property--(i) In general. If a transaction between a private foundation 
and a disqualified person is determined to be self-dealing (as defined 
in section 4941(d)), for purposes of section 4941 there is generally one 
act of self-dealing. For the date on which such act is treated as 
occurring, see paragraph (a)(2) of this section. If, however, such 
transaction relates to the leasing of property, the lending of money or 
other extension of credit, other use of money or property, or payment of 
compensation, the transaction will generally be treated (for purposes

[[Page 80]]

of section 4941 but not section 507 or section 6684) as giving rise to 
an act of self-dealing on the day the transaction occurs plus an act of 
self-dealing on the first day of each taxable year or portion of a 
taxable year which is within the taxable period and which begins after 
the taxable year in which the transaction occurs.
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. On August 31, 1970, X, a private foundation, sells a 
building to A, a disqualified person with respect to X. A is on the 
calendar year basis. Under these circumstances, the transaction between 
A and X is one act of self-dealing which is treated for purposes of 
section 4941 as occurring on August 31, 1970.
    Example 2. Assume the facts as stated in example (1), except that, 
instead of selling the building to A, X leases the building to A for a 
term of 4 years beginning July 31, 1970, at an annual rental of $12,000. 
The fair rental value of the building is also $12,000 per annum as of 
July 31, 1970, and throughout the next 4 years. This transaction is 
corrected on September 30, 1973, in accordance with paragraph (c)(4) of 
this section. Under these circumstances, the transaction between A and X 
constitutes four separate acts of self-dealing, which are treated for 
purposes of section 4941 as occurring on July 31, 1970, January 1, 1971, 
January 1, 1972, and January 1, 1973. Consequently, there are four 
taxable periods. The first taxable period is from July 31, 1970, to 
September 30, 1973; the second is from January 1, 1971, to September 30, 
1973; the third is from January 1, 1972, to September 30, 1973; and the 
fourth is from January 1, 1973, to September 30, 1973. For purposes of 
the initial taxes in section 4941(a), the amount involved is $5,000 for 
the first taxable period, $12,000 for the second, $12,000 for the third, 
and $9,000 for the fourth. The initial taxes to be paid by A are thus 
$1,000 ($5,000x5%x4 taxable years or partial taxable years in the 
taxable period) for the first act; $1,800 ($12,000x5%x3) for the second 
act; $1,200 ($12,000x5%x2) for the third act; and $450 ($9,000x5%x1) for 
the fourth act.
    Example 3. Assume the facts as stated in example (1) of Sec. 
53.4941(d)-4(c)(4)(ii). If the debentures are held by Y after December 
31, 1979, the extension of credit will not be excepted from the 
definition of an act of self-dealing, because an act of self-dealing 
will be treated (for purposes of section 4941) as occurring on January 
1, 1980.

    (2) Number of acts; joint participation by disqualified persons--(i) 
In general. If joint participation in a transaction by two or more 
disqualified persons constitutes self-dealing (such as a joint sale of 
property to a private foundation or joint use of its money or property), 
such transaction shall generally be treated as a separate act of self-
dealing with respect to each disqualified person for purposes of section 
4941. For purposes of section 507 and, in the case of a foundation 
manager, section 6684, however, such transaction shall be treated as 
only one act of self-dealing. For purposes of this subparagraph, an 
individual and one or more members of his family (within the meaning of 
section 4946(d)) shall be treated as one person, regardless of whether a 
member of the family is a disqualified person not only by reason of 
section 4946(a)(1)(D) but also by reason of another subparagraph of 
section 4946(a)(1). However, the liability imposed on a disqualified 
person and one or more members of his family for joint participation in 
an act of self-dealing shall be joint and several in accordance with 
section 4941(c)(1) and Sec. 53.4941(c)-1(a).
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. Private foundation X permits A, a substantial contributor 
to X, and her spouse, H, to use an automobile owned by X and normally 
used in its foundation activities to travel from State Z to State Y for 
a vacation on December 1, 1971. The automobile is then returned to X 
until December 21, 1971, when X again permits them to use the automobile 
to return to their home in State Z. Under these circumstances, there is 
one act of self-dealing on December 1, 1971, and a second act of self-
dealing on December 21, 1971.
    Example 2. Assume the facts as stated in example (1), except that B 
joined A and H on their vacation and traveled with them both to and from 
State Y. B is a disqualified person with respect to X, but he is not 
related by blood or marriage to A or H. Assume also that X is not paid 
for the use of its automobile, but that the fair rental value during the 
taxable period is $300 (or $100 per person) for a one-way trip between 
State Y and State Z. Under these circumstances, there are four acts of 
self-dealing, two with respect to A and H and two with respect to B. The 
amount involved with respect to A and H is $200 for each act, and the 
amount involved with respect to B is $100 for each act.

    (f) Fair market value. For purposes of Sec. Sec. 53.4941(a)-1 
through 53.4941 (f)-1, fair

[[Page 81]]

market value shall be determined pursuant to the provisions of Sec. 
53.4942(a)-2 (c)(4).

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 8084, 51 FR 
16301, May 2, 1986]



Sec. 53.4941(f)-1  Effective dates.

    (a) In general. Except as provided in paragraph (b) of this section, 
Sec. Sec. 53.4941(a)-1 through 53.4941(e)-1 shall apply to all acts of 
self-dealing engaged in after December 31, 1969.
    (b) Transitional rules--(1) Commitments made prior to January 1, 
1970, between private foundations and government officials. Section 4941 
shall not apply to a payment for one or more purposes described in 
section 170(c) (1) or (2)(B) made on or after January 1, 1970, by a 
private foundation to a government official, if such payment is made 
pursuant to a commitment entered into prior to such date, but only if 
such commitment was made in accordance with the foundation's usual 
practices and is reasonable in amount in light of the purposes of the 
payment. For purposes of this subparagraph, a commitment will be 
considered entered into prior to January 1, 1970, if prior to such date, 
the amount and nature of the payments to be made and the name of the 
payee were entered on the records of the payor, or were otherwise 
adequately evidenced, or the notice of the payment to be received was 
communicated to the payee in writing.
    (2) Special transitional rule. In the case of an act of self-dealing 
engaged in prior to July 5, 1971, section 4941(a) (1) shall not apply 
if:
    (i) The participation (as defined in Sec. 53.4941(a)-1(a)(3)) by 
the disqualified person in such act is not willful and is due to 
reasonable cause (as defined in Sec. 53.4941(a)-1(b) (4) and (5)),
    (ii) The transaction would not be a prohibited transaction if 
section 503(b) applied, and
    (iii) The act is corrected (within the meaning of Sec. 53.4941(e)-
1(c)) within a period ending [insert 90 days after date on which final 
regulations under section 4941 are filed by the Federal Register], 
extended (prior to the expiration of the original period) by any period 
which the Commissioner determines is reasonable and necessary (within 
the meaning of Sec. 53.4941(e)-1(d)) to bring about correction of the 
act of self-dealing.



             Subpart C_Taxes on Failure To Distribute Income

    Source: T.D. 7249, 38 FR 768, Jan. 4, 1973, unless otherwise noted.



Sec. 53.4942(a)-1  Taxes for failure to distribute income.

    (a) Imposition of tax--(1) Initial tax. Except as provided in 
paragraph (b) of this section, section 4942(a) imposes an excise tax of 
15 percent on the undistributed income (as defined in paragraph (a) of 
Sec. 53.4942(a)-2) of a private foundation for any taxable year which 
has not been distributed before the first day of the second (or any 
succeeding) taxable year following such taxable year (if such first day 
falls within the taxable period as defined in paragraph (c)(1) of this 
section). For purposes of section 4942 and this section, the term 
distributed means distributed as qualifying distributions under section 
4942(g). See paragraph (d)(2) of Sec. 53.4942(a)-3 with respect to 
correction of deficient distributions for prior taxable years.
    (2) Additional tax. In any case in which an initial excise tax is 
imposed by section 4942(a) on the undistributed income of a private 
foundation for any taxable year, section 4942(b) imposes an additional 
excise tax on any portion of such income remaining undistributed at the 
close of the correction period (as defined in paragraph (c)(1) of this 
section). The tax imposed by section 4942(b) is equal to 100 percent of 
the amount remaining undistributed at the close of the taxable period.
    (3) Payment of tax. Payment of the excise taxes imposed by section 
4942 (a) or (b) is in addition to, and not in lieu of, making the 
distribution of such undistributed income as required by section 4942. 
See section 507(a)(2) and the regulations thereunder.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a private foundation which uses the calendar year as 
its taxable year, has at the end of 1981, $50,000 of undistributed 
income (as defined in paragraph (a) of Sec. 53.4942 (a)-2) for 1981. As 
of January 1, 1983,

[[Page 82]]

$40,000 is still undistributed. On August 15, 1983, a notice of 
deficiency with respect to the excise taxes imposed by section 4942 (a) 
and (b) is mailed to M under section 6212 (a) and the taxable period 
ends. Thus, under these facts, an initial excise tax of $6,000 (15 
percent of $40,000) is imposed upon M. An additional excise tax of 
$40,000 (100 percent of $40,000) is imposed by section 4942(b). Under 
section 4961(a), however, if the undistributed income is reduced to zero 
during the correction period, this latter tax will not be assessed, and 
if assessed, it will be abated, and if collected, it will be credited or 
refunded as an overpayment.
    Example 2. Assume the facts as stated in example (1), except that 
the notice of deficiency is mailed to M on September 7, 1984, and as of 
January 1, 1984, only $10,000 of the $50,000 of undistributed income 
with respect to 1981 is undistributed. Therefore, initial excise taxes 
of $6,000 (15 percent of $40,000, M's undistributed income from 1981, as 
of January 1, 1983) and $1,500 (15 percent of $10,000, M's undistributed 
income from 1981 as of January 1, 1984) are imposed by section 4942(a). 
If the $10,000 remains undistributed as of September 7, 1984, the end of 
the taxable period, an additional excise tax of $10,000 (100 percent of 
$10,000, M's undistributed income from 1981, as of September 7, 1984) is 
imposed by section 4942(b).

    (b) Exceptions--(1) In general. The initial excise tax imposed by 
section 4942(a) shall not apply to the undistributed income of a private 
foundation:
    (i) For any taxable year for which it is an operating foundation (as 
defined in section 4942(j)(3) and the regulations thereunder), or
    (ii) To the extent that the foundation failed to distribute any 
amount solely because of incorrect valuation of assets under paragraph 
(c)(4) of Sec. 53.4942(a)-2, if:
    (a) The failure to value the assets properly was not willful and was 
due to reasonable cause,
    (b) Such amount is distributed as qualifying distributions (within 
the meaning of paragraph (a) of Sec. 53.4942 (a)-3) by the foundation 
during the allowable distribution period (as defined in paragraph (c)(2) 
of this section),
    (c) The foundation notifies the Commissioner that such amount has 
been distributed (within the meaning of subdivision (ii)(b) of this 
subparagraph) to correct such failure, and
    (d) Such distribution is treated under paragraph (d)(2) of Sec. 
53.4942(a)-3 as made out of the undistributed income for the taxable 
year for which a tax would (except for this subdivision) have been 
imposed by section 4942(a).
    (2) Improper valuation. For purposes of subparagraph (1)(ii) of this 
paragraph, failure to value an asset properly shall be regarded as ``not 
willful'' and ``due to reasonable cause'' whenever, under all the facts 
and circumstances, the foundation can show that it has made all 
reasonable efforts in good faith to value such an asset in accordance 
with the provisions of paragraph (c)(4) of Sec. 53.4942(a)-2. If a 
foundation, after full disclosure of the factual situation, obtains a 
bona fide appraisal of the fair market value of an asset by a person 
qualified to make such an appraisal (whether or not such a person is a 
disqualified person with respect to the foundation), and such foundation 
relies upon such appraisal, then failure to value the asset properly 
shall ordinarily be regarded as ``not willful'' and ``due to reasonable 
cause''. Notwithstanding the preceding sentence, the failure to obtain 
such a bona fide appraisal shall not, by itself, give rise to any 
inference that a foundation's failure to value an asset properly was 
willful or not due to reasonable cause.
    (3) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. In 1976 M, a private foundation which was established in 
1975 and which uses the calendar year as the taxable year, incorrectly 
values its assets under paragraph (c)(4) of Sec. 53.4942(a)-2 in a 
manner which is not willful and is due to reasonable cause. As a result 
of the incorrect valuation of assets, $20,000 which should be 
distributed with respect to 1976 is not distributed, and as of January 
1, 1978, such amount is still undistributed. On March 29, 1978, a notice 
of deficiency with respect to the excise taxes imposed by section 4942 
(a) and (b) is mailed to M under section 6212(a). On May 5, 1978 (within 
the allowable distribution period), M makes a qualifying distribution of 
$20,000 which is treated under paragraph (d)(2) of Sec. 53.4942(a)-3 as 
made out of M's undistributed income for 1976. M notifies the 
Commissioner of its action. Under the stated facts, an initial excise 
tax of $3,000 (15 percent of $20,000) would (except for the exception 
contained in subparagraph (1)(ii) of this paragraph) have been imposed 
by section 4942(a), but since all of the requirements of such 
subparagraph are satisfied no tax is imposed by section 4942(a).


[[Page 83]]


    (c) Certain periods. For purposes of this section--
    (1) Taxable period. (i) The term ``taxable period'' means, with 
respect to the undistributed income of a private foundation for any 
taxable year, the period beginning with the first day of the taxable 
year and ending on the earlier of:
    (A) The date of mailing of a notice of deficiency under section 
6212(a) with respect to the initial excise tax imposed under section 
4942(a), or
    (B) The date on which the initial excise tax imposed under section 
4942(a) is assessed.

For example, assume M, a private foundation which uses the calendar year 
as the taxable year, has $15,000 of undistributed income for 1981. A 
notice of deficiency is mailed to M under section 6212(a) on June 1, 
1983. With respect to the undistributed income of M for 1981, the 
taxable period began on January 1, 1981, and ended on June 1, 1983.
    (ii) Where a notice of deficiency referred to in subdivision (i) of 
this subparagraph is not mailed because there is a waiver of the 
restrictions on assessment and collection of a deficiency, or because 
the deficiency is paid, the date of filing of the waiver or the date of 
such payment, respectively, shall be treated as the end of the taxable 
period.
    (2) Allowable distribution period. (i) The term ``allowable 
distribution period'' means the period beginning with the first day of 
the first taxable year following the taxable year in which the incorrect 
valuation of foundation assets (described in paragraph (b)(1)(ii) of 
this section) occurred and ending 90 days after the date of mailing of a 
notice of deficiency under section 6212(a) with respect to the initial 
excise tax imposed by section 4942(a). This period shall be extended by 
any period in which a deficiency cannot be assessed under section 
6213(a), and any other period which the Commissioner determines is 
reasonable and necessary to permit a distribution of undistributed 
income under section 4942.
    (ii) Where a notice of deficiency referred to in subdivision (i) of 
this subparagraph is not mailed because there is a waiver of the 
restrictions on assessment and collection of a deficiency, or because 
the deficiency is paid, the date of filing of the waiver or the date of 
such payment, respectively, shall be treated as the end of the allowable 
distribution period.
    (3) Cross reference. For rules relating to taxable events that are 
corrected within the correction period, defined in section 4963(e), see 
section 4961 (a) and the regulations thereunder.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. In 1975 M, a private foundation which uses the calendar 
year as the taxable year, made an error in valuing its assets which was 
not willful and was due to reasonable cause. The error caused M not to 
distribute $25,000 that should have been distributed with respect to 
1975. On March 1, 1978, a notice of deficiency with respect to the 
excise taxes imposed by section 4942 (a) and (b) was mailed to M under 
section 6212(a). With respect to the undistributed income for 1975, the 
taxable period is the period from January 1, 1975, through March 1, 
1978, and the allowable distribution period is the period from January 
1, 1976, through May 30, 1978 (90 days after the mailing of the notice 
of deficiency).
    Example 2. Assume the facts as stated in example (1), except that 
the Commissioner determines that it is reasonable and necessary to 
extend the period for distribution through June 15, 1978. Thus, the 
allowable distribution period is from January 1, 1976, through June 15, 
1978.

    (d) Effective date. Except as otherwise specifically provided, 
section 4942 and the regulations thereunder shall only apply with 
respect to taxable years beginning after December 31, 1969.

[T.D. 7256, 38 FR 3317, Feb. 7, 1973, as amended by T.D. 8084, 51 FR 
16302, May 2, 1986]



Sec. 53.4942(a)-2  Computation of undistributed income.

    (a) Undistributed income. For purposes of section 4942, the term 
``undistributed income'' means, with respect to any private foundation 
for any taxable year as of any time, the amount by which:
    (1) The distributable amount (as defined in paragraph (b) of this 
section) for such taxable year, exceeds
    (2) The qualifying distributions (as defined in Sec. 53.4942(a)-3) 
made before such time out of such distributable amount.
    (b) Distributable amount--(1) In general. For purposes of paragraph 
(a) of this section, the term ``distributable amount'' means:

[[Page 84]]

    (i) For taxable years beginning before January 1, 1982, an amount 
equal to the greater of the minimum investment return (as defined in 
paragraph (c) of this section) or the adjusted net income (as defined in 
paragraph (d) of this section); and
    (ii) For taxable years beginning after December 31, 1981, an amount 
equal to the minimum investment return (as defined in paragraph (c) of 
this section), reduced by the sum of the taxes imposed on such private 
foundation for such taxable year under subtitle A of the Code and 
section 4940, and increased by the amounts received from trusts 
described in subparagraph (2) of this paragraph.
    (2) Certain trust amounts--(i) In general. The distributable amount 
shall be increased by the income portion (as defined in subdivision (ii) 
of this subparagraph) of distributions from trusts described in section 
4947(a)(2) with respect to amounts placed in trust after May 26, 1969. 
If such distributions are made with respect to amounts placed in trust 
both on or before and after May 26, 1969, such distributions shall be 
allocated between such amounts to determine the extent to which such 
distributions shall be included in the foundation's distributable 
amount. For rules relating to the segregation of amounts placed in trust 
on or before May 26, 1969, from amounts placed in trust after such date 
and to the allocation of income derived from such amounts, see paragraph 
(c) (5) of Sec. 53.4947-1.
    (ii) Income portion of distributions to private foundations. For 
purposes of subdivision (i) of this subparagraph, the income portion of 
a distribution from a section 4947(a)(2) trust to a private foundation 
in a particular taxable year of such foundation shall be the greater of:
    (a) The amount of such distribution which is treated as income 
(within the meaning of section 643(b)) of the trust, or
    (b) The guaranteed annuity, or fixed percentage of the fair market 
value of the trust property (determined annually), which the private 
foundation is entitled to receive for such year, regardless of whether 
such amount is actually received in such year or in any prior or 
subsequent year.
    (iii) Limitation. Notwithstanding subdivisions (i) and (ii) of this 
subparagraph, a private foundation shall not be required to distribute a 
greater amount for any taxable year than would have been required 
(without regard to this subparagraph) for such year had the corpus of 
the section 4947(a) (2) trust to which the distribution described in 
subdivision (ii) of this subparagraph is attributable been taken into 
account by such foundation as an asset described in paragraph (c) (1) 
(i) of this section.
    (c) Minimum investment return--(1) In general. For purposes of 
paragraph (b) of this section, the ``minimum investment return'' for any 
private foundation for any taxable year is the amount determined by 
multiplying:
    (i) The excess of the aggregate fair market value of all assets of 
the foundation, other than those described in subparagraph (2) or (3) of 
this paragraph, over the amount of the acquisition indebtedness with 
respect to such assets (determined under section 514(c)(1), but without 
regard to the taxable year in which the indebtedness was incurred), by
    (ii) The applicable percentage (as defined in subparagraph (5) of 
this paragraph) for such year.

For purposes of subdivision (i) of this subparagraph, the aggregate fair 
market value of all assets of the foundation shall include the average 
of the fair market values on a monthly basis of securities for which 
market quotations are readily available (within the meaning of 
subparagraph (4)(i)(a) of this paragraph), the average of the 
foundation's cash balances on a monthly basis (less the cash balances 
excluded from the computation of the minimum investment return by 
operation of subparagraph (3)(iv) of this paragraph), and the fair 
market value of all other assets (except those assets described in 
subparagraph (2) or (3) of this paragraph) for the period of time during 
the taxable year for which such assets are held by the foundation. Any 
determination of the fair market value of an asset required pursuant to 
the provisions of this subparagraph shall

[[Page 85]]

be made in accordance with the rules of subparagraph (4) of this 
paragraph.
    (2) Certain assets excluded. For purposes of this paragraph, the 
assets taken into account in determining minimum investment return shall 
not include the following:
    (i) Any future interest (such as a vested or contingent remainder, 
whether legal or equitable) of a foundation in the income or corpus of 
any real or personal property, other than a future interest created by 
the private foundation after December 31, 1969, until all intervening 
interests in, and rights to the actual possession or enjoyment of, such 
property have expired, or, although not actually reduced to the 
foundation's possession, until such future interest has been 
constructively received by the foundation, as where it has been credited 
to the foundation's account, set apart for the foundation, or otherwise 
made available so that the foundation may acquire it at any time or 
could have acquired it if notice of intention to acquire had been given;
    (ii) The assets of an estate until such time as such assets are 
distributed to the foundation or, due to a prolonged period of 
administration, such estate is considered terminated for Federal income 
tax purposes by operation of paragraph (a) of Sec. 1.641(b)-3 of this 
chapter (Income Tax Regulations);
    (iii) Any present interest of a foundation in any trust created and 
funded by another person (see, however, paragraph (b) (2) of this 
section with respect to amounts received from certain trusts described 
in section 4947(a) (2));
    (iv) Any pledge to the foundation of money or property (whether or 
not the pledge may be legally enforced); and
    (v) Any assets used (or held for use) directly in carrying out the 
foundation's exempt purpose.
    (3) Assets used (or held for use) in carrying out the exempt 
purpose--(i) In general. For purposes of subparagraph (2)(v) of this 
paragraph, an asset is ``used (or held for use) directly in carrying out 
the foundation's exempt purpose'' only if the asset is actually used by 
the foundation in the carrying out of the charitable, educational, or 
other similar purpose which gives rise to the exempt status of the 
foundation, or if the foundation owns the asset and establishes to the 
satisfaction of the Commissioner that its immediate use for such exempt 
purpose is not practical (based on the facts and circumstances of the 
particular case) and that definite plans exist to commence such use 
within a reasonable period of time. Consequently, assets which are held 
for the production of income or for investment (for example, stocks, 
bonds, interest-bearing notes, endowment funds, or, generally, leased 
real estate) are not being used (or held for use) directly in carrying 
out the foundation's exempt purpose, even though the income from such 
assets is used to carry out such exempt purpose. Whether an asset is 
held for the production of income or for investment rather than used (or 
held for use) directly by the foundation to carry out its exempt purpose 
is a question of fact. For example, an office building used for the 
purpose of providing offices for employees engaged in the management of 
endowment funds of the foundation is not being used (or held for use) 
directly by the foundation to carry out its charitable, educational, or 
other similar exempt purpose. However, where property is used both for 
charitable, educational, or other similar exempt purposes and for other 
purposes, if such exempt use represents 95 percent or more of the total 
use, such property shall be considered to be used exclusively for a 
charitable, educational, or other similar exempt purpose. If such exempt 
use of such property represents less than 95 percent of the total use, 
reasonable allocation between such exempt and nonexempt use must be made 
for purposes of this paragraph. Property acquired by the foundation to 
be used in carrying out its charitable, educational, or other similar 
exempt purpose may be considered as used (or held for use) directly to 
carry out such exempt purpose even though the property, in whole or in 
part, is leased for a limited period of time during which arrangements 
are made for its conversion to the use for which it was acquired, 
provided such income-producing use of the property does not exceed a 
reasonable period of time. Generally, 1 year shall be deemed to be a 
reasonable period of time for purposes of the immediately preceding 
sentence.

[[Page 86]]

For treatment of the income derived from such income-producing use, see 
paragraph (d)(2)(viii) of this section. Where the income-producing use 
continues beyond a reasonable period of time, the property shall not be 
deemed to be used by the foundation to carry out its charitable, 
educational, or other similar exempt purpose, but, instead, as of the 
time the income-producing use becomes unreasonable, such property shall 
be treated as disposed of within the meaning of paragraph (d)(2)(iii)(b) 
of this section to the extent that the acquisition of the property was 
taken into account as a qualifying distribution (within the meaning of 
paragraph (a)(2) of Sec. 53.4942(a-3) for any taxable year. If, 
subsequently, the property is used by the foundation directly in 
carrying out its charitable, educational, or other similar exempt 
purpose, a qualifying distribution in the amount of its then fair market 
value, determined in accordance with the rules contained in subparagraph 
(4) of this paragraph, shall be deemed to have been made as of the time 
such exempt use begins.
    (ii) Illustrations. Examples of assets which are ``used (or held for 
use) directly in carrying out the foundation's exempt purpose'' include, 
but are not limited to, the following:
    (a) Administrative assets, such as office equipment and supplies 
which are used by employees or consultants of the foundation, to the 
extent such assets are devoted to and used directly in the 
administration of the foundation's charitable, educational or other 
similar exempt activities;
    (b) Real estate or the portion of a building used by the foundation 
directly in its charitable, educational, or other similar exempt 
activities;
    (c) Physical facilities used in such activities, such as paintings 
or other works of art owned by the foundation which are on public 
display, fixtures and equipment in classrooms, research facilities and 
related equipment which under the facts and circumstances serve a useful 
purpose in the conduct of such activities;
    (d) Any interest in a functionally related business (as defined in 
subdivision (iii) of this subparagraph) or in a program-related 
investment (as defined in section 4944(c));
    (e) The reasonable cash balances (as described in subdivision (iv) 
of this subparagraph) necessary to cover current administrative expenses 
and other normal and current disbursements directly connected with the 
foundation's charitable, educational, or other similar exempt 
activities; and
    (f) Any property leased by a foundation in carrying out its 
charitable, educational, or other similar exempt purpose at no cost (or 
at a nominal rent) to the lessee or for a program-related purpose 
(within the meaning of section 4944(c)), such as the leasing of 
renovated apartments to low-income tenants at a low rental as part of 
the lessor foundation's program for rehabilitating a blighted portion of 
a community. For treatment of the income derived from such use, see 
paragraph (d) (2) (viii) of this section.
    (iii) Functionally related business--(a) In general. The term 
``functionally related business'' means:
    (1) A trade or business which is not an unrelated trade or business 
(as defined in section 513), or
    (2) An activity which is carried on within a larger aggregate of 
similar activities or within a larger complex of other endeavors which 
is related (aside from the need of the organization for income or funds 
or the use it makes of the profits derived) to the charitable, 
educational, or other similar exempt purpose of the organization.
    (b) Examples. The provisions of this subdivision may be illustrated 
by the following examples:

    Example 1. X, a private foundation, maintains a community of 
historic value which is open to the general public. For the convenience 
of the public, X, through a wholly owned, separately incorporated, 
taxable entity, maintains a restaurant and hotel in such community. Such 
facilities are within the larger aggregate of activities which makes 
available for public enjoyment the various buildings of historic 
interest and which is related to X's exempt purpose. Thus, the operation 
of the restaurant and hotel under such circumstances constitutes a 
functionally related business.
    Example 2. Y, a private foundation, as part of its medical research 
program under section 501(c) (3), publishes a medical journal in 
carrying out its exempt purpose. Space in

[[Page 87]]

the journal is sold for commercial advertising. Notwithstanding the fact 
that the advertising activity may be subject to the tax imposed by 
section 511, such activity is within a larger complex of endeavors which 
makes available to the scientific community and the general public 
developments with respect to medical research and is therefore a 
functionally related business.

    (iv) Cash held for charitable, etc. activities. For purposes of 
subdivision (ii)(e) of this subparagraph, the reasonable cash balances 
which a private foundation needs to have on hand to cover expenses and 
disbursements described in such subdivision will generally be deemed to 
be an amount, computed on an annual basis, equal to one and one-half 
percent of the fair market value of all assets described in subparagraph 
(1)(i) of this paragraph, without regard to subdivision (ii)(e) of this 
subparagraph. However, if the Commissioner is satisfied that under the 
facts and circumstances an amount in addition to such one and one-half 
percent is necessary for payment of such expenses and disbursements, 
then such additional amount may also be excluded from the amount of 
assets described in subparagraph (1)(i) of this paragraph. All remaining 
cash balances, including amounts necessary to pay any tax imposed by 
section 511 or any section of chapter 42 of the Code except section 
4940, are to be included in the assets described in subparagraph (1)(i) 
of this paragraph.
    (4) Valuation of assets--(i) Certain securities. (a) For purposes of 
subparagraph (1)(i) of this paragraph, a private foundation may use any 
reasonable method to determine the fair market value on a monthly basis 
of securities for which market quotations are readily available, as long 
as such method is consistently used. For purposes of this subparagraph, 
market quotations are readily available if a security is:
    (1) Listed on the New York Stock Exchange, the American Stock 
Exchange, or any city or regional exchange in which quotations appear on 
a daily basis, including foreign securities listed on a recognized 
foreign national or regional exchange;
    (2) Regularly traded in the national or regional over-the-counter 
market, for which published quotations are available; or
    (3) Locally traded, for which quotations can readily be obtained 
from established brokerage firms.
    (b) For purposes of this subdivision, commonly accepted methods of 
valuation must be used in making an appraisal. Valuations made in 
accordance with the principles stated in the regulations under section 
2031 constitute acceptable methods of valuation. This paragraph 
(c)(4)(i)(b) applies only for taxable years beginning before January 1, 
1976. See section 4942(e)(2)(B) and paragraph (c)(4)(i)(c) of this 
section for special valuation rules that apply for subsequent taxable 
years.
    (c) For purposes of this subdivision (i) and with respect to taxable 
years beginning after December 31, 1975, if the private foundation can 
show that the value of securities determined on the basis of market 
quotations as provided by subdivision (i)(a) does not reflect the fair 
market value thereof because:
    (1) The securities constitute a block of securities so large in 
relation to the volume of actual sales on the existing market that it 
could not be liquidated in a reasonable time without depressing the 
market.
    (2) The securities are securities in a closely held corporation and 
sales are few or of a sporadic nature, and, or
    (3) The sale of the securities would result in a forced or distress 
sale because the securities could not be offered to the public for sale 
without first being registered under the Securities Act of 1933 or 
because of other factors,

then the price at which the securities could be sold as such outside the 
usual market, as through an underwriter, may be a more accurate 
indication of value than market quotations. On the other hand, if the 
securities to be valued represents a controlling interest, either actual 
or effective, in a going business, the price at which other lots change 
hands may have little relation to the true value of the securities. No 
decrease in the fair market value of any given class of securities 
determined on the basis of market quotations as provided by subdivision 
(i)(a) shall be allowed except as authorized by this subdivision, and no 
such decrease shall in the aggregate exceed 10 percent of the fair 
market value of

[[Page 88]]

such class of securities so determined on the basis of market quotations 
and without regard to this subdivision.
    (d) In the case of securities described in subdivision (i)(a) of 
this subparagraph, which are held in trust for, or on behalf of, a 
foundation by a bank or other financial institution which values such 
securities periodically by use of a computer, a foundation may determine 
the correct value of such securities by use of such computer pricing 
system, provided the Commissioner has accepted such computer pricing 
system as a valid method for valuing securities for Federal estate tax 
purposes.
    (e) This subdivision may be illustrated by the following examples:

    Example 1. U, a private foundation, owns 1,000 shares of the stock 
of M Corporation. M stock is regularly traded on the New York Stock 
Exchange. U consistently follows a practice of valuing its 1,000 shares 
of M stock on the last trading day of each month based upon the quoted 
closing price for M stock. U's method of valuing its M Corporation stock 
is permissible under the rules contained in subdivision (i)(a) of this 
subparagraph.
    Example 2. Assume the facts as stated in example (1), except that U 
consistently follows a practice of valuing its 1,000 shares of M stock 
by taking the mean of the closing prices for M stock on the first and 
last trading days of each month and the trading day nearest the 15th day 
of each month. U's method of valuing its M stock is permissible under 
the rules contained in subdivision (i)(a) of this subparagraph.
    Example 3. Assume the facts as stated in example (1), except that U 
consistently follows a practice of valuing its M stock by taking the 
mean of the highest and lowest quoted prices for the stock on the last 
trading day of each month. U's method of valuing its M stock is 
permissible under the rules contained in subdivision (1)(a) of this 
subparagraph.
    Example 4. V, a private foundation, owns 1,000 shares of the stock 
of N Corporation. N stock is regularly traded in the national over-the-
counter market and published quotations of the bid and asked prices for 
the stock are available. V consistently follows a practice of valuing 
its 1,000 shares of N stock on the first trading day of each month by 
taking the mean of the bid and asked prices on that day. V's method of 
valuing its N Corporation stock is permissible under the rules contained 
in subdivision (i)(a) of this subparagraph.
    Example 5. W, a private foundation, owns 1,000 shares of the stock 
of O Corporation. O stock is locally traded and quotations can readily 
be obtained from established brokerage firms. W consistently follows a 
practice of valuing its O stock on the 15th day of each month by 
obtaining a bona fide quotation of bid and asked prices for the stock 
from an established brokerage firm and taking the mean of such prices on 
that day. If a quotation is unavailable on the regular valuation date, W 
values its O stock based upon a bona fide quotation on the first day 
thereafter on which such a quotation is available. W's method of valuing 
its O Corporation stock is permissible under the rules contained in 
subdivision (i)(a) of this subparagraph.

    (ii) Cash. In order to determine the amount of a foundation's cash 
balances, the foundation shall value its cash on a monthly basis by 
averaging the amount of cash on hand as of the first day of each month 
and as of the last day of each month.
    (iii) Common trust funds. If a private foundation owns a 
participating interest in a common trust fund (as defined in section 
584) established and administered under a plan providing for the 
periodic valuation of participating interests during the fund's taxable 
year and the reporting of such valuations to participants, the value of 
the foundation's interest in the common trust fund based upon the 
average of the valuations reported to the foundation during its taxable 
year will ordinarily constitute an acceptable method of valuation.
    (iv) Other assets. (a) Except as otherwise provided in subdivision 
(iv)(b) of this subparagraph, the fair market value of assets other than 
those described in subdivisions (i) through (iii) of this subparagraph 
shall be determined annually. Thus, the fair market value of securities 
other than those described in subdivision (i) of this subparagraph shall 
be determined in accordance with this subdivision (a). If, however, a 
private foundation owns voting stock of an issuer of unlisted securities 
and has, or together with disqualified persons or another private 
foundation has, effective control of the issuer (within the meaning of 
Sec. 53.4943-3(b)(3)(ii), then to the extent that the issuer's assets 
consist of shares of listed securities issues, such assets shall be 
valued monthly on the basis of market quotations or in accordance with 
section 4942(e)(2)(B), if applicable.

[[Page 89]]

Thus, for example, if a private foundation and a disqualified person 
together own all of the unlisted voting stock of a holding company which 
in turn holds a portfolio of securities of issues which are listed on 
the New York Stock Exchange, in determining the net worth of the holding 
company, the underlying portfolio securities are to be valued monthly by 
reference to market quotations for their issues unless a decrease in 
such value is authorized in accordance with section 4942(e)(2)(b). Such 
determination may be made by employees of the private foundation or by 
any other person, without regard to whether such person is a 
disqualified person with respect to the foundation. A valuation made 
pursuant to the provisions of this subdivision, if accepted by the 
Commissioner, shall be valid only for the taxable year for which it is 
made. A new valuation made in accordance with these provisions is 
required for the succeeding taxable year.
    (b) If the requirements of this subdivision are met, the fair market 
value of any interest in real property, including any improvements 
thereon, may be determined on a 5-year basis. Such value must be 
determined by means of a certified, independent appraisal made in 
writing by a qualified person who is neither a disqualified person with 
respect to, nor an employee of, the private foundation. The appraisal is 
certified only if it contains a statement at the end thereof to the 
effect that, in the opinion of the appraiser, the values placed on the 
assets appraised were determined in accordance with valuation principles 
regularly employed in making appraisals of such property using all 
reasonable valuation methods. The foundation shall retain a copy of the 
independent appraisal for its records. If a valuation made pursuant to 
the provisions of this subdivision in fact falls within the range of 
reasonable values for the appraised property, such valuation may be used 
by the foundation for the taxable year for which the valuation is made 
and for each of the succeeding 4 taxable years. Any valuation made 
pursuant to the provisions of this subdivision may be replaced during 
the 5-year period by a subsequent 5-year valuation made in accordance 
with the rules set forth in this subdivision, or with an annual 
valuation made in accordance with subdivision (iv)(a) of this 
subparagraph, and the most recent such valuation of such assets shall be 
used in computing the foundation's minimum investment return. In the 
case of a foundation organized before May 27, 1969, a valuation made in 
accordance with this subdivision applicable to the foundation's first 
taxable year beginning after December 31, 1972, and the 4 succeeding 
taxable years must be made no later than the last day of such first 
taxable year. In the case of a foundation organized after May 26, 1969, 
a valuation made in accordance with this subdivision applicable to the 
foundation's first taxable year beginning after February 5, 1973 and the 
succeeding 4 taxable years must be made no later than the last day of 
such first taxable year. Any subsequent valuation made in accordance 
with this subdivision must be made no later than the last day of the 
first taxable year for which such new valuation is applicable. A 
valuation, if properly made in accordance with the rules set forth in 
this subdivision, will not be disturbed by the Commissioner during the 
5-year period for which it applies even if the actual fair market value 
of such property changes during such period.
    (c) For purposes of this subdivision, commonly accepted methods of 
valuation must be used in making an appraisal. Valuations made in 
accordance with the principles stated in the regulations under section 
2031 constitute acceptable methods of valuation. The term appraisal, as 
used in this subdivision, means a determination of fair market value and 
is not to be construed in a technical sense peculiar to particular 
property or interests therein, such as, for example, mineral interests 
in real property.
    (v) Definition of ``securities''. For purposes of this subparagraph, 
the term ``securities'' includes, but is not limited to, common and 
preferred stocks, bonds, and mutual fund shares.
    (vi) Valuation date. (a) In the case of an asset which is required 
to be valued on an annual basis as provided in subdivision (iv)(a) of 
this subparagraph, such asset may be valued as of any day in the private 
foundation's taxable

[[Page 90]]

year to which such valuation applies, provided the foundation follows a 
consistent practice of valuing such asset as of such date in all taxable 
years.
    (b) A valuation described in subdivision (iv)(b) of this 
subparagraph may be made as of any day in the first taxable year of the 
private foundation to which such valuation is to be applied.
    (vii) Assets held for less than a taxable year. For purposes of this 
paragraph, any asset described in subparagraph (1)(i) of this paragraph 
which is held by a foundation for only part of a taxable year shall be 
taken into account for purposes of determining the foundation's minimum 
investment return for such taxable year by multiplying the fair market 
value of such asset (as determined pursuant to this subparagraph) by a 
fraction, the numerator of which is the number of days in such taxable 
year that the foundation held such asset and the denominator of which is 
the number of days in such taxable year.
    (5) Applicable percentage--(i) In general. For purposes of paragraph 
(c)(1)(ii) of this section, except as provided in paragraph (c)(5)(ii) 
or (iii) of this section, the applicable percentage is:
    (a) Six percent for a taxable year beginning in 1970 or 1971;
    (b) Five and a half percent for a taxable year beginning in 1972;
    (c) Five and one-quarter percent for a taxable year beginning in 
1973;
    (d) Six percent for a taxable year beginning in 1974 or 1975; and
    (e) Five percent for taxable years beginning after Dec. 31, 1975.
    (ii) Transitional rule. In the case of organizations organized 
before May 27, 1969 (including organizations deemed to be so organized 
by virtue of the provisions of paragraph (e)(2) of this section), 
section 4942 shall, for all purposes other than the determination of the 
minimum investment return under section 4942(j)(3)(B)(ii), for taxable 
years:
    (a) Beginning before January 1, 1972, apply without regard to 
section 4942(e).
    (b) Beginning in 1972, apply with an applicable percentage of 4\1/8\ 
percent,
    (c) Beginning in 1973, apply with an applicable percentage of 4\3/8\ 
percent and
    (d) Beginning in 1974, apply with an applicable percentage of 5\1/2\ 
percent.
    (iii) Short taxable periods. In any case in which a taxable year 
referred to in this subparagraph is a period less than 12 months, the 
applicable percentage to be applied to the amount determined under the 
provisions of subparagraph (1) of this paragraph shall be equal to the 
applicable percentage for the calendar year in which the short taxable 
period began multiplied by a fraction, the numerator of which is the 
number of days in such short taxable period and the denominator of which 
is 365.
    (d) Adjusted net income--(1) Definition. For purposes of paragraph 
(b) of this section, the term ``adjusted net income'' means the excess 
(if any) of:
    (i) The gross income for the taxable year (including gross income 
from any unrelated trade or business) determined with the income 
modifications provided by subparagraph (2) of this paragraph, over
    (ii) The sum of the deductions (including deductions directly 
connected with the carrying on of any unrelated trade or business), 
determined with the deduction modifications provided by subparagraph (4) 
of this paragraph, which would be allowed to a corporation subject to 
the tax imposed by section 11 for the taxable year.

In computing the income includible under this paragraph as gross income 
and the deductions allowable under this paragraph from such income, the 
principles of subtitle A of the Code shall apply except to the extent 
such principles conflict with section 4942 and the regulations 
thereunder (without regard to this sentence). Except as otherwise 
provided in this paragraph, no exclusions or deductions from gross 
income or credits against tax are allowable under this paragraph. For 
purposes of subdivision (i) of this subparagraph, the term ``gross 
income'' does not include gifts, grants, or contributions received by 
the private foundation but does include income from a functionally 
related business (as defined in paragraph (c)(3)(iii) of this section).
    (2) Income modifications. The income modifications referred to in 
subparagraph (1)(i) of this paragraph are as follows:

[[Page 91]]

    (i) Section 103 (relating to interest on certain governmental 
obligations) shall not apply. Hence, interest which would have been 
excluded from gross income by section 103 shall be included in gross 
income.
    (ii) Capital gains and losses from the sale or other disposition of 
property shall be taken into account only in an amount equal to any net 
short-term capital gain (as defined in section 1222(5)) for the taxable 
year. Long-term capital gain or loss is not included in the computation 
of adjusted net income. Similarly, net section 1231 gains shall be 
excluded from the computation of adjusted net income. However, net 
section 1231 losses shall be included in the computation of adjusted net 
income, if such losses are otherwise described in subparagraph (1)(ii) 
of this paragraph. Any net short-term capital loss for a given taxable 
year shall not be taken into account in computing adjusted net income 
for such year or in computing net short-term capital gain for purposes 
of determining adjusted net income for prior or future taxable years 
regardless of whether the foundation is a corporation or a trust.
    (iii) The following amounts shall be included in gross income for 
the taxable year:
    (a) Amounts received or accrued as repayments of amounts which were 
taken into account as a qualifying distribution within the meaning of 
paragraph (a)(2)(i) of Sec. 53.4942(a)-3 for any taxable year;
    (b) Notwithstanding subdivision (ii) of this subparagraph, gross 
amounts received or accrued from the sale or other disposition of 
property to the extent that the acquisition of such property was taken 
into account as a qualifying distribution (within the meaning of 
paragraph (a)(2)(ii) of Sec. 53.4942(a)-3) for any taxable year; and
    (c) Any amount set aside under paragraph (b) of Sec. 53.4942(a)-3 
to the extent it is determined that such amount is not necessary for the 
purposes for which it was set aside.
    (iv) Any distribution received by a private foundation from a 
disqualified person in redemption of stock held by such private 
foundation in a business enterprise shall be treated as not essentially 
equivalent to a dividend under section 302(b)(1) if all of the following 
conditions are satisfied:
    (a) Such redemption is of stock which was owned by a private 
foundation on May 26, 1969 (or which is acquired by a private foundation 
under the terms of a trust which was irrevocable on May 26, 1969, or 
under the terms of a will executed on or before such date which are in 
effect on such date and at all times thereafter);
    (b) Such foundation is required to dispose of such property in order 
not to be liable for tax under section 4943 (relating to taxes on excess 
business holdings) applied, in the case of a disposition before January 
1, 1975, without taking section 4943(c)(4) into account; and
    (c) Such foundation receives in return an amount which equals or 
exceeds the fair market value of such property at the time of such 
disposition or at the time a contract for such disposition was 
previously executed in a transaction which would not constitute a 
prohibited transaction (within the meaning of section 503(b) or the 
corresponding provisions of prior law).
    (v) If, as of the date of distribution of property for purposes 
described in section 170(c) (1) or (2)(B), the fair market value of such 
property exceeds its adjusted basis, such excess shall not be deemed an 
amount includible in gross income.
    (vi) The income received by a private foundation from an estate 
during the period of administration of such estate shall not be included 
in such foundation's gross income, unless, due to a prolonged period of 
administration, such estate is considered terminated for Federal income 
tax purposes by operation of paragraph (a) of Sec. 1.641(b)-3 of this 
chapter (Income Tax Regulations).
    (vii) Distributions received by a private foundation from a trust 
created and funded by another person shall not be included in the 
foundation's gross income. However, with respect to distributions from 
certain trusts described in section 4947(a)(2), see paragraph (b)(2) of 
this section.
    (viii) Gross income shall include all amounts derived from, or in 
connection with, property held by the foundation, even though the fair 
market value of such property may not be included in

[[Page 92]]

such foundation's assets for purposes of determining minimum investment 
return by operation of paragraph (c)(3) of this section.
    (ix) Gross income shall include amounts treated in a preceding 
taxable year as a ``qualifying distribution'' by operation of paragraph 
(c) of Sec. 53.4942(a)-3 where such amounts are not redistributed by 
the close of the donee organization's succeeding taxable year in 
accordance with the rules prescribed in such paragraph (c). In such 
cases, such amounts shall be included in the donor foundation's gross 
income for such foundation's first taxable year beginning after the 
close of the donee organization's first taxable year following the donee 
organization's taxable year of receipt.
    (x) For taxable years ending after October 4, 1976, section 
4942(f)(2)(D) states that section 483 (relating to imputed interest on 
deferred payments) does not apply to payments made pursuant to a binding 
contract entered into in a taxable year beginning before January 1, 
1970. Amounts that are not treated as imputed interest because of 
section 4942(f)(2)(D) and this subdivision will represent gain or loss 
from the sale of property. If the gain or loss is long term capital gain 
or loss, section 4942(f)(2)(B) excludes the gain or loss from the 
computation of the foundation's gross income. If, in a taxable year 
beginning after December 31, 1969, there is a substantial change in the 
terms of a contract entered into in a taxable year beginning before 
January 1, 1970, then any payment made pursuant to the changed contract 
is not considered a payment made pursuant to a contract entered into in 
a taxable year beginning before January 1, 1970. Whether or not a change 
in the terms of a contract (for example, a change relating to time of 
payment, sales price, or obligations under the contract) is a 
substantial change is determined by applying the rules under section 483 
and Sec. 1.483-1(b)(4). As used in this subdivision, a binding contract 
includes an irrevocable written option.
    (3) Adjusted basis--(i) In general. For purposes of subparagraph 
(2)(ii) of this paragraph, the adjusted basis for purposes of 
determining gain from the sale or other disposition of property shall be 
determined in accordance with the rules set forth in subdivision (ii) of 
this subparagraph and the adjusted basis for purposes of determining 
loss from such disposition shall be determined in accordance with the 
rules set forth in subdivision (iii) of this subparagraph. Further, the 
provisions of this subparagraph do not apply for any purpose other than 
for purposes of subparagraph (2)(ii) of this paragraph. For example, the 
determination of gain pursuant to the provisions of section 341 is 
determined without regard to this subparagraph.
    (ii) Gain from sale or other disposition. The adjusted basis for 
purposes of determining gain from the sale or other disposition of 
property shall be the greater of:
    (a) The fair market value of such property on December 31, 1969, 
plus or minus all adjustments after December 31, 1969, and before the 
date of sale or other disposition under the rules of Part II, Subchapter 
O, Chapter 1 of the Code, provided that the property was held by the 
private foundation on December 31, 1969, and continuously thereafter to 
such date of sale or other disposition; or
    (b) The adjusted basis as determined under the rules of Part II, 
Subchapter O, Chapter 1 of the Code, subject to the provisions of 
section 4940(c)(3)(B) and the regulations thereunder (and without regard 
to section 362(c)). With respect to assets acquired prior to December 
31, 1969, which were subject to depreciation or depletion, for purposes 
of determining the adjustments to be made to basis between the date of 
acquisition and December 31, 1969, and amount equal to straight-line 
depreciation or cost depletion shall be taken into account. In addition, 
in determining such adjustments to basis, if any other adjustments would 
have been made during such period (such as a change in useful life based 
upon additional data or a change in facts), such adjustments shall also 
be taken into account.
    (iii) Loss from sale or other disposition. For purposes of 
determining loss from the sale or other disposition of property, 
adjusted basis as determined in subdivision (ii)(b) of this subparagraph 
shall apply.

[[Page 93]]

    (iv) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. A private foundation, which uses the cash receipts and 
disbursements method of accounting, purchased certain depreciable real 
property on December 1, 1969. On December 31, 1969, the fair market 
value of such property was $100,000 and its adjusted basis (determined 
under the provisions of this subparagraph) was $102,000. The property 
was sold on January 2, 1970, for $105,000. Because fair market value on 
December 31, 1969, $100,000, is less than the adjusted basis as 
determined by Part II, Subchapter O, Chapter 1 of the Code, $102,000, a 
short-term gain of $3,000 is recognized (i.e., sale price of $105,000 
less the greater of the two possible bases) for purposes of subparagraph 
(2)(ii) of this paragraph.
    Example 2. Assume the facts as stated in example (1), except that 
the sale price was $95,000. Because the sale price was $7,000 less than 
the adjusted basis for loss ($102,000 as determined by the application 
of subdivision (iii) of this subparagraph), there is a capital loss of 
$7,000 which may be deducted against short-term capital gains for 1970 
(if any) in determining net short-term capital gain.
    Example 3. A private foundation, which uses the cash receipts and 
disbursements method of accounting, purchased unimproved land on 
December 1, 1969. On December 31, 1969, the fair market value of such 
property was $110,000 and its adjusted basis (determined under the 
provisions of this subparagraph) was $102,000. The property was sold on 
January 2, 1970, for $105,000. Since the fair market value on December 
31, 1969, $110,000, exceeds the adjusted basis as determined by Part II, 
Subchapter O, Chapter 1 of the Code, $102,000, such fair market value 
will be used for purposes of determining gain. However, because the 
adjusted basis for purposes of determining gain exceeds the sale price, 
there is no gain. Furthermore, because the adjusted basis for purposes 
of determining loss, $102,000, is less than sale price, there is no 
loss.

    (4) Deduction modifications--(i) In general. For purposes of 
computing adjusted net income under subparagraph (1) of this paragraph, 
no deduction shall be allowed other than all the ordinary and necessary 
expenses paid or incurred for the production or collection of gross 
income or for the management, conservation, or maintenance of property 
held for the production of such income, except as provided in 
subdivision (ii) of this subparagraph. Such expenses include that 
portion of a private foundation's operating expenses which is paid or 
incurred for the production or collection of gross income. Operating 
expenses include compensation of officers, other salaries and wages of 
employees, interest, rent, and taxes. Where only a portion of the 
property produces (or is held for the production of) income subject to 
the provisions of section 4942, and the remainder of the property is 
used for charitable, educational, or other similar exempt purposes, the 
deductions allowed by this subparagraph shall be apportioned between the 
exempt and nonexempt uses. Similarly, where the deductions with respect 
to property used for a charitable, educational, or other similar exempt 
purpose exceed the income derived from such property, such excess shall 
not be allowed as a deduction, but may be treated as a qualifying 
distribution described in paragraph (a)(2)(ii) of Sec. 53.4942(a)-3. 
Furthermore, this subdivision does not allow deductions which are not 
paid or incurred for the purposes herein prescribed. Thus, for example, 
the deductions prescribed by the following sections are not allowable: 
(a) The charitable contributions deduction prescribed under sections 170 
and 642(c); (b) the net operating loss deduction prescribed under 
section 172; and (c) the special deductions prescribed under Part VIII, 
Subchapter B, Chapter 1 of the Code.
    (ii) Special rules. For purposes of computing adjusted net income 
under subparagraph (1) of this paragraph: (a) The allowances for 
depreciation and depletion as determined under section 4940(c)(3)(B) and 
the regulations thereunder shall be taken into account, and (b) section 
265 (relating to expenses and interest relating to tax-exempt interest) 
shall not apply.
    (e) Certain transitional rules--(1) In general. In the case of 
organizations organized before May 27, 1969, section 4942 shall:
    (i) Not apply to an organization to the extent its income is 
required to be accumulated pursuant to the mandatory terms (as in effect 
on May 26, 1969, and at all times thereafter) of an instrument executed 
before May 27, 1969, with respect to the transfer of income producing 
property to such organization, except that section 4942 shall

[[Page 94]]

apply to such organization if the organization would have been denied 
exemption had section 504(a) not been repealed, or would have had its 
deductions under section 642(c) limited had section 681(c) not been 
repealed. In applying the preceding sentence, in addition to the 
limitations contained in section 504(a) or 681(c) before its repeal, 
section 504(a)(1) or 681(c)(1) shall be treated as not applying to an 
organization to the extent its income is required to be accumulated 
pursuant to the mandatory terms (as in effect on January 1, 1951, and at 
all times thereafter) of an instrument executed before January 1, 1951, 
with respect to the transfer of income producing property to such 
organization before such date, if such transfer was irrevocable on such 
date; and
    (ii) Not apply to an organization which is prohibited by its 
governing instrument or other instrument from distributing capital or 
corpus to the extent the requirements of section 4942 are inconsistent 
with such prohibitions.
    (2) Certain existing organizations. For purposes of this section, an 
organization will be deemed to be organized prior to May 26, 1969, if it 
is either a testamentary trust created under the will of an individual 
who died prior to such date or an inter visos trust which was in 
existence and irrevocable prior to such date, even though it is not 
funded until after May 26, 1969. Similarly, a split-interest trust, as 
described in section 4947(a)(2) (without regard to section 
4947(a)(2)(C)), which became irrevocable prior to May 27, 1969, and 
which is treated as a private foundation under section 4947(a)(1) 
subsequent to such date, likewise shall be treated as an organization 
organized prior to such date. See section 507(b)(2) and the regulations 
thereunder with respect to the applicability of transitional rules where 
there has been a merger of two or more private foundations or a 
reorganization of a private foundation.
    (3) Limitation. With respect to taxable years beginning after 
December 31, 1971, subparagraph (1) (i) and (ii) of this paragraph shall 
apply only for taxable years during which there is pending any judicial 
proceeding by the private foundation which is necessary to reform, or to 
excuse such foundation from compliance with, its governing instrument or 
any other instrument (as in effect on May 26, 1969) in order to comply 
with the provisions of section 4942, and in the case of subparagraph 
(1)(i) of this paragraph for all taxable years following the taxable 
year in which such judicial proceeding is terminated during which the 
governing instrument or any other instrument does not permit compliance 
with such provisions. Thus, the exception described in subparagraph 
(1)(ii) of this paragraph applies after 1971 only for taxable years 
during which such judicial proceeding is pending. Accordingly, beginning 
with the first taxable year following the taxable year in which such 
judicial proceeding is terminated, such foundation will be required to 
meet the requirements of section 4942 and the regulations thereunder 
(and be subject to the taxes provided upon failure to do so) except to 
the extent such foundation is required to accumulate income as described 
in subparagraph (1)(i) of this paragraph, even if the governing 
instrument continues to prohibit invasion of capital or corpus. In any 
case where a foundation's governing instrument or any other instrument 
requires accumulation of income as described in subparagraph (1)(i) of 
this paragraph beginning with the first taxable year following the 
taxable year in which such judicial proceeding is terminated, the 
distributable amount (as defined in paragraph (b) of this section) for 
such foundation shall be reduced by the amount of the income required to 
be accumulated. Therefore, if the foundation's adjusted net income for 
any taxable year equals or exceeds its minimum investment return for 
such year, the accumulation provisions will be given full effect. 
However, if the minimum investment return exceeds the adjusted net 
income for any taxable year, the foundation will be required to 
distribute such excess for such year. For purposes of this paragraph, a 
judicial proceeding will be treated as pending only if the foundation is 
diligently pursuing its judicial remedies and there is no unreasonable 
delay in such proceeding for which the private foundation is 
responsible.

[[Page 95]]

    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. X, a private foundation organized in 1930, is required by 
the mandatory terms of its governing instrument to accumulated 25 
percent of its adjusted net income and to add such accumulations to 
corpus. The instrument also prohibits distribution of corpus for any 
purpose. On July 13, 1971, X instituted an action in the appropriate 
State court to reform the instrument by deleting the accumulation and 
corpus provisions described above. If the court's final order reforms 
the accumulation provisions to allow distributions of income sufficient 
to avoid the imposition of a tax under section 4942, then section 4942 
applies to X, regardless of the court's action with respect to the 
corpus provisions. However, if the court rules that the accumulation 
provision may not be reformed, section 4942 applies to X only to the 
extent provided for in subparagraph (3) of this paragraph, regardless of 
the court's action with respect to the corpus provision.
    Example 2. Private foundation Y was created by the will of A who 
died in 1940. Y's governing instrument requires that 40 percent of Y's 
adjusted net income be added to corpus each year. In an action commenced 
prior to December 31, 1971, a court of competent jurisdiction rules that 
this accumulation provisions must be complied with. In Y's succeeding 
taxable year its adjusted net income is $120,000, and its minimum 
investment return is $140,000. Thus, Y is required to accumulated 
$48,000 (40 percent of $120,000) and shall be allowed to do so. 
Therefore, Y's distributable amount for such taxable year shall be the 
greater of its adjusted net income ($120,000) or its minimum investment 
return ($140,000), reduced by the amount of the income required to be 
accumulated ($48,000) and the taxes imposed by Subtitle A of the Code 
and section 4940 and increased by any trust distributions described in 
paragraph (b)(2) of this section. Accordingly, Y's distributable amount 
for such taxable year is $92,000 ($140,000 reduced by $48,000), before 
other adjustments. If Y's minimum investment return had been $120,000 
instead of $140,000, its distributable amount for such taxable year 
would have been $72,000 ($120,000 reduced by $48,000), before other 
adjustments. Similarly, if Y's minimum investment return had been 
$100,000 instead of $140,000, its distributable amount for such taxable 
year would also have been $72,000, before other adjustments.

[T.D. 7256, 38 FR 3317, Feb. 5, 1973; 38 FR 4577, Feb. 16, 1973, as 
amended by T.D. 7486, 42 FR 24265, May 13, 1977; T.D. 7594, 44 FR 7138, 
Feb. 6, 1979; T.D. 7610, 44 FR 21644, Apr. 11, 1979; T.D. 7715, 45 FR 
56803, Aug. 26, 1980; T.D. 7849, 47 FR 50857, Nov. 10, 1982; T.D. 7878, 
48 FR 11943, Mar. 22, 1983]



Sec. 53.4942(a)-3  Qualifying distributions defined.

    (a) In general--(1) Distributions generally. For purposes of section 
4942 and the regulations thereunder, the amount of a qualifying 
distribution of property (as defined in subparagraph (2) of this 
paragraph) is the fair market value of such property as of the date such 
qualifying distribution is made. The amount of an organization's 
qualifying distributions will be determined solely on the cash receipts 
and disbursements method of accounting described in section 446(c)(1).
    (2) Definition. The term qualifying distribution means:
    (i) Any amount (including program-related investments, as defined in 
section 4944(c), and reasonable and necessary administrative expenses) 
paid to accomplish one or more purposes described in section 170(c) (1) 
or (2)(B), other than any contribution to:
    (a) A private foundation which is not an operating foundation (as 
defined in section 4942(j)(3)), except as provided in paragraph (c) of 
this section, or
    (b) An organization controlled (directly or indirectly) by the 
contributing private foundation or one or more disqualified persons with 
respect to such foundation, except as provided in paragraph (c) of this 
section;
    (ii) Any amount paid to acquire an asset used (or held for use) 
directly in carrying out one or more purposes described in section 
170(c) (1) or (2)(B). See paragraph (c)(3) of Sec. 53.4942(a)-2 for the 
definition of used (or held for use); or
    (iii) Any amount set aside within the meaning of paragraph (b) of 
this section.
    (3) Control. For purposes of subparagraph (2)(i)(b) of this 
paragraph, an organization is ``controlled'' by a foundation or one or 
more disqualified persons with respect to the foundation if

[[Page 96]]

any of such persons may, by aggregating their votes or positions of 
authority, require the donee organization to make an expenditure, or 
prevent the donee organization from making an expenditure, regardless of 
the method by which the control is exercised or exercisable. ``Control'' 
of a donee organization is determined without regard to any conditions 
imposed upon the donee as part of the distribution or any other 
restrictions accompanying the distribution as to the manner in which the 
distribution is to be used, unless such conditions or restrictions are 
described in paragraph (a)(8) of Sec. 1.507-2 of this chapter (Income 
Tax Regulations). In general, it is the donee, not the distribution, 
which must be ``controlled'' by the distributing private foundation for 
the provisions of subparagraph (2)(i)(b) of this paragraph to apply. 
Thus, the furnishing of support to an organization and the consequent 
imposition of budgetary procedures upon that organization with respect 
to such support shall not in itself be treated as subjecting that 
organization to the distributing foundation's control within the meaning 
of this subparagraph. Such ``budgetary procedures'' include expenditure 
responsibility requirements under section 4945(d)(4). The ``controlled'' 
organization need not be a private foundation; it may be any type of 
exempt or nonexempt organization including a school, hospital, operating 
foundation, or social welfare organization.
    (4) Borrowed funds--(i) In general. For purposes of this paragraph, 
if a private foundation borrows money in a particular taxable year to 
make expenditures for a specific charitable educational, or other 
similar purpose, a qualifying distribution out of such borrowed funds 
will, except as otherwise provided in subdivision (ii) of this 
subparagraph, be deemed to have been made only at the time that such 
borrowed funds are actually distributed for such exempt purpose.
    (ii) Funds borrowed before 1970. (a) If a private foundation has 
borrowed money in a taxable year beginning before January 1, 1970, or 
subsequently borrows money pursuant to a written commitment which was 
binding as of the last day of such taxable year, to make expenditures 
for a specific charitable, educational, or other similar exempt purpose, 
if such borrowed funds are in fact expended for such purpose in any 
taxable year, and if such loan is thereafter repaid, in whole or in 
part, in a taxable year beginning after December 31, 1969, then, at the 
election of the foundation as provided in subdivision (ii)(b) of this 
subparagraph, a qualifying distribution will be deemed to have been made 
at such time or times that such loan principal is so repaid rather than 
at the earlier time that the borrowed funds were actually distributed 
for such exempt purpose.
    (b) The election described in subdivision (ii)(a) of this 
subparagraph is to be made by attaching a statement to the form the 
private foundation is required to file under section 6033 for the first 
taxable year beginning after December 31, 1969, in which a repayment of 
loan principal is made. Such statement shall be made a part of such form 
and shall be attached to such form in each succeeding taxable year in 
which any repayment of loan principal is made. The statement shall set 
forth the name and address of the lender, the amount borrowed, the 
specific use made of such borrowed funds, and the private foundation's 
election to treat repayments of loan principal as qualifying 
distributions.
    (iii) Interest. Any payment of interest with respect to a loan 
described in subdivision (i) or (ii) of this subparagraph shall be 
treated as a deduction under paragraph (d)(1)(ii) of Sec. 53.4942(a)-2 
in the taxable year in which it is made.
    (5) Changes in use of an asset. If an asset not used (or held for 
use) directly in carrying out one or more purposes described in section 
170(c) (1) or (2)(B) is subsequently converted to such a use, the 
foundation may treat such conversion as a qualifying distribution. The 
amount of such qualifying distribution shall be the fair market value of 
the converted asset as of the date of its conversion. For purposes of 
the preceding sentence, fair market value shall be determined by making 
a valuation of the converted asset as of the date of its conversion in 
accordance with the rules set forth in paragraph (c)(4) of Sec. 
53.4942(a)-2.

[[Page 97]]

    (6) Certain foreign organizations--(i) In general. Distributions for 
purposes described in section 170(c)(2)(B) to a foreign organization, 
which has not received a ruling or determination letter that it is an 
organization described in section 509(a) (1), (2), or (3) or 4942(j)(3), 
will be treated as a distribution made to an organization described in 
section 509(a) (1), (2), or (3) or 4942(j)(3) if the distributing 
foundation has made a good faith determination that the donee 
organization is an organization described in section 509(a) (1), (2), or 
(3) or 4942(j)(3). Such a ``good faith determination'' ordinarily will 
be considered as made where the determination is based on an affidavit 
of the donee organization or an opinion of counsel (of the distributing 
foundation or the donee organization) that the donee is an organization 
described in section 509(a) (1), (2), or (3) or 4942(j)(3). Such an 
affidavit or opinion must set forth sufficient facts concerning the 
operations and support of the donee organization for the Internal 
Revenue Service to determine that the donee organization would be likely 
to qualify as an organization described in section 509(a) (1), (2), or 
(3) or 4942(j)(3).
    (ii) Definition. For purposes of this subparagraph, the term foreign 
organization means any organization which is not described in section 
170(c)(2)(A).
    (7) Payment of tax. The payment of any tax imposed under chapter 42 
of the Code shall not be treated as a qualifying distribution.
    (8) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a private foundation which uses the calendar year as 
the taxable year, makes the following payments in 1970: (i) a payment of 
$44,000 to five employees for conducting a foundation program of 
educational grants for research and study; (ii) $20,000 for various 
items of overhead, 10 percent of which is attributable to the activities 
of the employees mentioned in payment (i) of this example and the other 
90 percent of which is attributable to administrative expenses which 
were not paid to accomplish any section 170(c) (1) or (2)(B) purpose; 
and (iii) a $100,000 general purpose grant paid to an educational 
institution described in section 170(b)(1)(A)(ii) which is not 
controlled by M or any disqualified persons with respect to M. Payments 
(i) and (ii) of this example are qualifying distributions to the extent 
of $46,000 ($44,000 of salaries and 10 percent of the overhead, both of 
which are reasonable administrative expenses paid to accomplish section 
170(c) (1) or (2)(B) purposes). Payment (iii) of this example is also a 
qualifying distribution, since it is a contribution for section 
170(c)(2)(B) purposes to an organization which is not described in 
subparagraph (2)(i) (a) or (b) of this paragraph. The other 90 percent 
of payment (ii) of this example may constitute items of deduction under 
paragraph (d)(1)(ii) of Sec. 53.4942(a)-2 if such items otherwise 
qualify under such paragraph.
    Example 2. On February 21, 1972, N, a private foundation which uses 
the calendar year as the taxable year, pays $500,000 for real property 
on which it plans to build hospital facilities to be used for medical 
care and education. The real property produces no income and the 
hospital facilities will not be constructed until 1974 according to the 
setaside plan submitted to and approved by the Commissioner pursuant to 
paragraph (b) of this section. The purchase of the land is a qualifying 
distribution under subparagraph (2)(ii) of this paragraph. If, however, 
the property used were to produce rental income for more than a 
reasonable period of time before construction of the hospital is begun, 
then as of the time such rental use becomes unreasonable (i) such 
purchase would no longer constitute a qualifying distribution under 
subparagraph (2)(ii) of this paragraph, and (ii) the amount of the 
qualifying distribution would be included in N's gross income. See 
paragraphs (c)(3)(i) and (d)(2)(iii)(b) of Sec. 53.4942(a)-2.
    Example 3. In 1971, X, a private foundation engaged in holding 
paintings and exhibiting them to the public, purchases an additional 
building to be used to exhibit the paintings. Such expenditure is a 
qualifying distribution under subparagraph (2)(ii) of this paragraph. In 
1975, X sells the building. Under paragraph (d)(2)(iii)(b) of Sec. 
53.4942(a)-2, all of the proceeds of the sale (less direct costs of the 
sale) are included in X's adjusted net income for 1975.
    Example 4. In January 1969, M, a private foundation which uses the 
calendar year as the taxable year, borrows $10 million to give to N, a 
private college, for the construction of a science center. M borrowed 
the money from X, a commercial bank. M is to repay X at the rate of $1.1 
million per year ($1 million principal and $0.1 million interest) for 10 
years, beginning in January, 1973. M distributed $5 million of the 
borrowed funds to N in February 1969 and the other $5 million in March 
1970. M files a statement with the form it is required to file under 
section 6033 for 1973 which contains the information required by 
subparagraph (4)(ii)(b) of this paragraph. Pursuant to M's election, 
each repayment of loan principal constitutes a qualifying distribution 
in the year of repayment. Accordingly, the distribution of $5 million to

[[Page 98]]

N in March 1970 will not be treated as a qualifying distribution. Each 
payment of interest ($0.1 million annually) with respect to M's loan 
from X is treated as a deduction under paragraph (d)(1)(ii) of Sec. 
53.4942(a)-2 in the taxable year in which it is made.
    Example 5. Private foundation Y engages in providing care for the 
aged. Y makes a distribution of cash to H, a hospital described in 
section 170(b)(1)(A)(iii) which is not controlled by Y or any 
disqualified person with respect to Y. The distribution is made subject 
to the conditions that H will invest the money as a separate fund which 
will bear a name commemorating the creator of Y and will use the income 
from such fund only for H's exempt hospital purposes which relate to 
care for the aged. Under these circumstances, the distribution from Y to 
H is a qualifying distribution pursuant to subparagraph (2)(i) of this 
paragraph.

    (b) Certain set-asides--(1) In general. An amount set aside for a 
specific project that is for one or more of the purposes described in 
section 170(c) (1) or (2)(B) may be treated as a qualifying distribution 
in the year in which set aside (but not in the year in which actually 
paid), if the requirements of section 4942(g)(2) and this paragraph (b) 
are satisfied. The requirements of this paragraph (b) are satisfied if 
the private foundation establishes to the satisfaction of the 
Commissioner that the amount set aside will be paid for the specific 
project within 60 months after it is set aside, and
    (i) The set-aside satisfies the suitability test described in 
subparagraph (2) of this paragraph, or
    (ii) With respect to a set-aside made in a taxable year beginning 
after December 31, 1974, the private foundation satisfies the cash 
distribution test described in subparagraph (3) of this paragraph.

If the suitability test or cash distribution test is otherwise 
satisfied, the 60 month period for paying the amount set aside may, for 
good cause shown, be extended by the Commissioner.
    (2) Suitability test. The suitability test is satisfied if the 
private foundation establishes to the satisfaction of the Commissioner 
that the specific project for which the amount is set aside is one that 
can be better accomplished by the set-aside than by the immediate 
payment of funds. Specific projects that can be better accomplished by 
the use of a set-aside include, but are not limited to, projects in 
which relatively long-term grants or expenditures must be made in order 
to assure the continuity of particular charitable projects or program-
related investments (as defined in section 4944(c)) or where grants are 
made as part of a matching-grant program. Such projects include, for 
example, a plan to erect a building to house the direct charitable, 
educational, or other similar exempt activity of the private foundation 
(such as a museum building in which paintings are to be hung), even 
though the exact location and architectural plans have not been 
finalized; a plan to purchase an additional group of paintings offered 
for sale only as a unit that requires an expenditure of more than one 
year's income; or a plan to fund a specific research program that is of 
such magnitude as to require an accumulation of funds before beginning 
the research, even though not all of the details of the program have 
been finalized.
    (3) Cash distribution test; in general. The cash distribution test 
is satisfied if:
    (i) The specific project for which the amount is set aside will not 
be completed before the end of the taxable year in which the set-aside 
is made,
    (ii) The private foundation actually distributes, in cash or its 
equivalent and for one or more of the purposes described in section 
170(c) (1) or (2)(B), the ``start-up period minimum amount'' described 
in subparagraph (4) of this paragraph during the private foundation's 
start-up period, and
    (iii) The private foundation actually distributes, in cash or its 
equivalent and for one or more of the purposes described in section 
170(c) (1) or (2)(B), the ``full-payment period minimum amount'' 
described in subparagraph (5) of this paragraph in each taxable year of 
the private foundation's full-payment period.

For purposes of the cash distribution test, an amount set aside will be 
treated as distributed in the year in which actually paid and not in the 
year in which set aside.
    (4) Minimum distribution required during start-up period--(i) Start-
up period. For private foundations created before January 1, 1972, the 
start-up period is

[[Page 99]]

the four taxable years immediately preceding the taxable year beginning 
in calendar year 1976. For private foundations created after December 
31, 1971 (or for organizations that first become private foundations 
after that date), the start-up period is the four taxable years 
following the taxable year in which the private foundation was created 
(or otherwise became a private foundation). For purposes of this 
subparagraph (4), a private foundation will be considered ``created'' in 
the taxable year in which the private foundation's distributable amount 
(as determined under section 4942(d)) first exceeds $500.
    (ii) Start-up period minimum amount. The amount that a private 
foundation must actually distribute in cash or its equivalent during the 
private foundation's start-up period is not less than the sum of:
    (a) Twenty percent of the private foundation's distributable amount 
(as determined under section 4942(d)) for the first taxable year of the 
start-up period,
    (b) Forty percent of the private foundation's distributable amount 
for the second taxable year of the start-up period,
    (c) Sixty percent of the private foundation's distributable amount 
for the third taxable year of the start-up period, and
    (d) Eighty percent of the private foundation's distributable amount 
for the fourth taxable year of the start-up period.
    (iii) Timing of distributions. The requirement that a private 
foundation distribute the start-up period minimum amount during the 
start-up period is a requirement that such amount be distributed before 
the end of the start-up period, and is not a requirement that any 
portion of such amount be distributed in any one taxable year of the 
start-up period.
    (iv) Distribution actually made during start-up period. In general, 
only a distribution actually made during the start-up period is taken 
into account in determining whether a private foundation has distributed 
the start-up period minimum amount. However, in the case of a private 
foundation created after December 31, 1971 (or an organization that 
first became a private foundation after that date), a distribution 
actually made during the taxable year in which the foundation was 
created (the year immediately preceding the first taxable year of the 
private foundation's start-up period) may be treated as a distribution 
actually made during the start-up period. In addition, a distribution 
actually made by a private foundation within 5\1/2\ months after the end 
of the start-up period will be treated as a distribution actually made 
during the start-up period if:
    (a) The private foundation was unable to determine the distributable 
amount for the fourth taxable year of the start-up period until after 
the end of such period, and
    (b) The private foundation actually made distributions prior to the 
end of the start-up period based upon a reasonable estimate of the 
private foundation's distributable amount for the fourth taxable year of 
the start-up period.
    (v) Examples. The provisions of this subparagraph (4) may be 
illustrated by the following examples:

    Example 1. F, a private foundation created on January 1, 1975, uses 
the calendar year as its taxable year. The start-up period for F is 
January 1, 1976 through December 31, 1979. F has distributable amounts 
under section 4942(d) for taxable years 1976 through 1979 in the 
following amounts: 1976, $100,000; 1977, $120,000; 1978, $150,000; 1979, 
$200,000. F's start-up period minimum amount is the sum of the following 
amounts: 20% of $100,000 ($20,000); 40% of $120,000 ($48,000); 60% of 
$150,000 ($90,000); and 80% of $200,000 ($160,000); which equals 
$318,000. Thus F is required to actually distribute at least $318,000 in 
cash or its equivalent during the start-up period.
    Example 2. F, a private foundation created in 1969, uses the 
calendar year as its taxable year. F's start-up period is the calendar 
years 1972 through 1975. F makes two cash distributions in 1972. The 
first distribution is made on account of a set-aside made in 1969. Under 
section 4942(g), that distribution is treated as a qualifying 
distribution made in 1969. The second distribution is treated under 
section 4942(h) has made out of F's undistributed income for 1971. In 
addition, F makes a cash distribution in 1976 that is treated under 
section 4942(h) as made out of F's undistributed income for 1975. In 
determining whether F has distributed its start-up period minimum amount 
within the start-up period, the 1972 distributions are both taken into 
account because they were actually made during F's start-up period. The 
1976 distribution is not taken into account, however, because

[[Page 100]]

that distribution was not actually made during F's start-up period.

    (5) Minimum distribution required during full-payment period--(i) 
Full-payment period. A private foundation's full-payment period includes 
each taxable year that begins after the end of the private foundation's 
start-up period.
    (ii) Full-payment period minimum amount. The amount that a private 
foundation must actually distribute in cash or its equivalent in a 
taxable year of the private foundation's full-payment period is not less 
than 100 percent of the private foundation's distributable amount 
determined under section 4942(d) (without regard to section 4942(i)) 
with respect to the taxable year.
    (iii) Carryover of distributions in excess of full-payment period 
minimum amount. If, in a taxable year beginning after December 31, 1975, 
a private foundation distributes an amount in excess of the full-payment 
period minimum amount for the taxable year, the excess shall be used to 
reduce the full-payment period minimum amount in the taxable years in 
the adjustment period. The amount of the excess distribution used to 
reduce the full-payment period minimum amount in each successive taxable 
year of the adjustment period shall be equal to the amount of such 
excess less the sum of the full-payment period minimum amounts for all 
prior taxable years in the adjustment period to which the excess was 
previously applied. The taxable years in the adjustment period are the 
five taxable years immediately following the taxable year in which the 
excess distribution is made. Any distribution in excess of the full-
payment period minimum amount made during a taxable year of the 
adjustment period shall not be taken into account under this 
subparagraph (iii) until any earlier excess has been completely applied 
against full-payment period minimum amounts during its adjustment 
period.
    (iv) Distributions actually made during a taxable year. Except as 
described in subdivision (ii) of subparagraph (6), only a distribution 
actually made during a taxable year of the full-payment period is taken 
into account in determining whether a private foundation has distributed 
the full-payment period minimum amount for such year.
    (v) Examples. The provisions of this subparagraph (5) may be 
illustrated by the following examples:

    Example 1. F, a private foundation created on January 1, 1973, uses 
the calendar year as its taxable year. F has a start-up period of 
January 1, 1974, through December 31, 1977, and a full-payment period 
that includes every taxable year beginning after December 31, 1977. F's 
distributable amount (as determined under section 4942(d)) for 1978 is 
$500,000. Thus, F's full-payment period minimum amount for 1978 is 
$500,000. During 1978 F distributes $100,000 in cash to Charity X and 
$400,000 in cash to Charity Y on account of a set-aside made in 1973. F 
has distributed its full-payment period minimum amount for 1978 because 
it has made actual cash distributions during that year which total 
$500,000. However, F has made qualifying distributions (as determined 
under section 4942(g)) with respect to 1978 of only $100,000. In order 
to avoid liability for the tax on undistributed income under section 
4942(a), F must distribute or set aside an additional $400,000 before 
January 1, 1980.
    Example 2. Assume the facts as stated in Example (1) except that in 
1978 F makes cash distributions totaling $600,000. Since the total cash 
distributions made in 1978 ($600,000) exceed the full-payment period 
minimum amount for 1978 ($500,000), there exists a $100,000 excess which 
must be used by F to reduce its full-payment period minimum amounts for 
the years 1979-1983 (the taxable years in the adjustment period with 
respect to the 1978 excess). Therefore, if F's distributable amount (as 
determined under section 4942(d)) for 1979 is $500,000, F's full-payment 
period minimum amount for 1979 is $400,000 ($500,000-$100,000).

    (6) Failure to distribute minimum amounts--(i) In general. If a 
private foundation fails to actually distribute the start-up period 
minimum amount during the start-up period or, except as described in 
subdivision (ii) of this subparagraph (6), if a private foundation fails 
to actually distribute the full-payment period minimum amount during a 
taxable year of the full-payment period, then any set-aside made by the 
private foundation during the start-up period (if the failure relates to 
the start-up period) or during the taxable year (if the failure relates 
to the full-payment period) that was not approved by the Commissioner 
under the suitability test described in subparagraph (2) of this 
paragraph will not be treated

[[Page 101]]

as a qualifying distribution. Further, any set-aside made after the year 
of such a failure to so distribute a minimum amount will be treated as a 
qualifying distribution only if the Commissioner approves the set-aside 
under the suitability test. In any case in which a set-aside ceases to 
be treated as a qualifying distribution as a result of a failure to 
distribute the full-payment period minimum amount, a private foundation 
may be assessed a deficiency under section 4942(a) within the period 
described in section 6501(n)(3).
    (ii) Correction of certain failures to distribute. If a private 
foundation's failure to distribute the full-payment period minimum 
amount during a taxable year of the full-payment period was not willful 
and was due to reasonable cause, the private foundation may correct the 
failure to so distribute. Correction will be achieved if the private 
foundation distributes within the correction period cash or its 
equivalent in an amount not less than the difference between the full-
payment period minimum amount for the taxable year and the amount 
actually distributed during the taxable year. The correction period is 
the correction period as defined in section 4962(e), determined with 
respect to the earliest occurring taxable event (as defined in section 
4962(e)(2)(A)) that would result if the failure to distribute a full-
payment period minimum amount were not corrected. The additional 
distribution will be treated for purposes of subparagraph (5) of this 
paragraph as made during the taxable year with respect to which the 
failure occurred. If a private foundation fails to distribute the full-
payment period minimum amount during a taxable year of the full-payment 
period because such amount can be determined only after the end of the 
taxable year, no ``willful failure to distribute'' the full-payment 
period minimum amount will occur if the private foundation makes an 
additional distribution within 5\1/2\ months after the end of the 
taxable year.
    (7) Approval and information requirements--(i) Suitability test. If 
an amount is set aside under the suitability test of section 
4942(g)(2)(B)(i) and subparagraph (2) of this paragraph, the private 
foundation must apply for the Commissioner's approval of the set-aside 
before the end of the taxable year in which the amount is set aside. The 
Commissioner will either approve or disapprove the set-aside in writing. 
An otherwise proper set-aside will not be treated as a qualifying 
distribution under this paragraph (b) with respect to a taxable year if 
the Commissioner's approval is not sought before the end of the taxable 
year in which the amount is actually set aside. To obtain approval by 
the Commissioner for a set-aside under the suitability test, the private 
foundation must write to Commissioner of Internal Revenue, Attention: 
OP:E:EO:T, 1111 Constitution Avenue, NW., Washington, DC 20224, and 
include:
    (a) A statement describing the nature and purposes of the specific 
project and the amount of the set-aside for which approval is requested;
    (b) A statement describing the amounts and approximate dates of any 
planned additions to the set-aside after its initial establishment;
    (c) A statement of the reasons why the project can be better 
accomplished by a set-aside than by the immediate payment of funds;
    (d) A detailed description of the project, including estimated 
costs, sources of any future funds expected to be used for completion of 
the project, and the location or locations (general or specific) of any 
physical facilities to be acquired or constructed as part of the 
project; and
    (e) A statement by an appropriate foundation manager (as defined in 
section 4946(b)) that the amounts to be set aside will actually be paid 
for the specific project within a specified period of time that ends not 
more than 60 months after the date of the first set-aside, or a 
statement showing good cause why the period for paying the amount set 
aside should be extended (including a showing that the proposed project 
could not be divided into two or more projects covering periods of no 
more than 60 months each) and setting forth the extension of time 
required.
    (ii) Cash distribution test. If an amount is set aside under the 
cash distribution test of section 4942(g)(2)(B)(ii) and subparagraphs 
(3), (4), and (5) of this paragraph, then for taxable years

[[Page 102]]

ending after April 2, 1984, the private foundation must submit an 
attachment with the return required by section 6033 for the taxable year 
in which the amount is set aside and for certain subsequent taxable 
years. For the taxable year in which the amount is set aside the 
attachment must include:
    (a) A statement describing the nature and purposes of the specific 
project for which amounts are to be set aside;
    (b) A statement that the amounts set aside for the specific project 
will actually be paid for the specific project within a specified period 
of time that ends not more than 60 months after the date of the set-
aside;
    (c) A statement that the project will not be completed before the 
end of the taxable year of the private foundation in which the set-aside 
is made;
    (d) A statement showing the distributable amounts determined under 
section 4942(d) for any past taxable years in the private foundation's 
start-up and full-payment periods; and
    (e) A statement showing the aggregate amount of actual payments made 
in cash or its equivalent, for purposes described in section 170(c) (1) 
or (2)(B), during each taxable year in the private foundation's start-up 
and full-payment periods. This statement should include a detailed 
description of any payments that are to be treated, pursuant to the 
rules of subparagraphs (4)(iv) and (6)(ii) of this paragraph (b), as 
distributed during a taxable year prior to the taxable year in which 
such payments were actually made and, in addition, should explain the 
circumstances that justify the application of those rules.

For the five taxable years following the taxable year in which the 
amount is set aside (or, if longer, for each taxable year in the 
extended period for paying the amount set aside), the attachment must 
include the statements required by (d) and (e) of this subdivision (ii). 
The submission of the statement required by (b) of this subdivision (ii) 
will satisfy the requirement of section 4942(g)(2)(B) and subparagraph 
(1) of this paragraph (b) that the private foundation establish to the 
satisfaction of the Commissioner that the amount set aside will be paid 
for the specific project within 60 months after it is set aside.
    (8) Evidence of set-aside. A set-aside that is approved by the 
Commissioner or which satisfies the cash distribution test shall be 
evidenced by the entry of a dollar amount on the books and records of a 
private foundation as a pledge or obligation to be paid at a future date 
or dates. Any amount which is set aside shall be taken into account for 
purposes of determining the private foundation's minimum investment 
return under Sec. 53.4942(a)-2 (c)(1), and any income attributable to 
such set-aside shall be taken into account in computing adjusted net 
income under Sec. 53.4942(a)-2(d).
    (9) Contingent set-aside. In the event a private foundation is 
involved in litigation and may not distribute assets or income because 
of a court order, the private foundation may (except as provided in 
Sec. 53.4942(a)-2 (e)(1)(i) or (ii)) seek and obtain a set-aside for a 
purpose described in Sec. 53.4942(a)-3 (a)(2). The amount to be set 
aside shall be equal to that portion of the private foundation's 
distributable amount which is attributable to the assets or income that 
are held pursuant to court order and which, but for the court order 
precluding the distribution of such assets or income, would have been 
distributed. In the event that the litigation encompasses more than one 
taxable year, the private foundation may seek additional contingent set-
asides. Such amounts must actually be distributed by the last day of the 
taxable year following the taxable year in which the litigation is 
terminated. Amounts not distributed by the close of the appropriate 
taxable year shall be treated as described in Sec. 53.4942(a)-2 
(d)(2)(iii)(c) for the succeeding taxable year.
    (c) Certain contributions to section 501(c)(3) organizations--(1) In 
general. For purposes of this section, the term ``qualifying 
distribution'' includes (in the year in which it is paid) a contribution 
to an exempt organization described in section 501(c)(3) and described 
in paragraph (a)(2)(i) (a) or (b) of this section if:
    (i) Not later than the close of the first taxable year after the 
donee organization's taxable year in which such contribution is 
received, such donee organization makes a distribution equal

[[Page 103]]

to the full amount of such contribution and such distribution is a 
qualifying distribution (within the meaning of paragraph (a) of this 
section, without regard to this paragraph) which is treated under 
paragraph (d) of this section as a distribution out of corpus (or would 
be so treated if such section 501(c)(3) organization were a private 
foundation which is not an operating foundation); and
    (ii) The private foundation making the contribution obtains adequate 
records or other sufficient evidence from such donee organization (such 
as a statement by an appropriate officer, director, or trustee of such 
donee organization) showing (except as otherwise provided in this 
subparagraph) (a) that the qualifying distribution described in 
subdivision (i) of this subparagraph has been made by such organization, 
(b) the names and addresses of the recipients of such distribution and 
the amount received by each, and (c) that the distribution is treated as 
a distribution out of corpus under paragraph (d) of this section (or 
would be so treated if the donee organization were a private foundation 
which is not an operating foundation). Where a distribution is for an 
administrative expense which is part of a section 170(c) (1) or (2)(B) 
expenditure or is part of another section 170(c) (1) or (2)(B) 
expenditure that cannot reasonably be separately accounted for, the 
provisions of subdivision (ii) of this subparagraph may be satisfied by 
the submission by the donee organization of a statement setting forth 
the general purpose for which such expenditure was made and that the 
amount was distributed as a qualifying distribution described in 
subdivision (ii)(c) of this subparagraph.
    (2) Distribution requirements. (i) In order for a donee organization 
to meet the distribution requirements of subparagraph (1)(i) of this 
paragraph, it must, not later than the close of the first taxable year 
after its taxable year in which any contributions are received, 
distribute (within the meaning of this subparagraph) an amount equal in 
value to the contributions received in such prior taxable year and have 
no remaining undistributed income for such prior taxable year. In the 
event that a donee organization redistributes less than an amount equal 
to the total contributions from donor organizations which are required 
to be redistributed by such donee organization by the close of the first 
taxable year following the taxable year in which such contributions were 
received, amounts treated as redistributions of such contributions shall 
be deemed to have been made pro rata out of all such contributions 
regardless of any earmarking or identification made by such donee 
organization with respect to the source of such distributions. See 
paragraph (d)(2)(ix) of Sec. 53.4942(a)-2 for the treatment of amounts 
deemed not to have been so redistributed. For purposes of this 
paragraph, the term contributions means all contributions, whether of 
cash or property, and the fair market value of contributed property 
determined as of the date of the contribution must be used in 
determining whether an amount equal in value to the contributions 
received has been redistributed.
    (ii) For purposes of this paragraph, the characterization of 
qualifying distributions made during the taxable year (i.e., whether out 
of the prior year's undistributed income, the current year's 
undistributed income, or corpus) is to be made as of the close of the 
taxable year in question, except to the extent that a different 
characterization is effected by means of the election provided for by 
paragraph (d)(2) of this section or by subdivision (iv) of this 
subparagraph. Once it is determined that a qualifying distribution is 
attributable to corpus, such distribution will first be charged to 
distributions which are required to be redistributed under this 
paragraph.
    (iii) All amounts contributed to a specific exempt organization 
described in section 501(c)(3) and in paragraph (a)(2)(i) (a) or (b) of 
this section within any one taxable year of such organization shall be 
treated (with respect to the contributing private foundation) as one 
``contribution''. If subparagraph (1) (i) or (ii) of this paragraph is 
not completely satisfied with respect to such contribution within the 
meaning of such subparagraph, only that portion

[[Page 104]]

of such contribution which was redistributed (within the meaning of 
subparagraph (1) (i) and (ii) of this paragraph) shall be treated as a 
qualifying distribution.
    (iv) In order to satisfy distribution requirements under section 
170(b) (1)(E)(ii) or this paragraph, a donee organization may elect to 
treat as a current distribution out of corpus any amount distributed in 
a prior taxable year which was treated as a distribution out of corpus 
under paragraph (d)(1)(iii) of this section provided that (a) such 
amount has not been availed of for any other purpose, such as a 
carryover under paragraph (e) of this section or a redistribution under 
this paragraph for a prior year, (b) such corpus distribution occurred 
within the preceding 5 years, and (c) such amount is not later availed 
of for any other purpose. Such election must be made by attaching a 
statement to the return the foundation is required to file under section 
6033 with respect to the taxable year for which such election is to 
apply. Such statement must contain a declaration by an appropriate 
foundation manager (within the meaning of section 4946(b)(1)) that the 
foundation is making an election under this paragraph and it must 
specify that the distribution was treated under paragraph (d)(1)(iii) of 
this section as a distribution out of corpus in a designated prior 
taxable year (or years).
    (3) Examples. The provisions of subparagraphs (1) and (2) of this 
paragraph may be illustrated by the following examples. It is assumed in 
these examples that all private foundations described use the calendar 
as the taxable year.

    Example 1. In 1972 M, a private foundation, makes a contribution out 
of 1971 income to X, another private foundation which is not an 
operating foundation. The contribution is the only one received by X in 
1972. In 1973 X makes a qualifying distribution to an art museum 
maintained by an operating foundation in an amount equal to the amount 
of the contribution received from M. X also distributes all of its 
undistributed income for 1972 and 1973 for other purposes described in 
section 170(c)(2)(B). Under the provisions of paragraph (d) of this 
section, such distribution to the museum is treated as a distribution 
out of corpus. Thus, M's contribution to X is a qualifying distribution 
out of M's 1971 income provided M obtains adequate records or other 
sufficient evidence from X showing the nature and amount of the 
distribution made by X, the identity of the recipient, and the fact that 
the distribution is treated as made out of corpus. If X's qualifying 
distributions during 1973 had been equal only to M's contribution to X 
and X's undistributed income for 1972, X could have made an election 
under paragraph (d)(2) of this section to treat the amount distributed 
in excess of its 1972 undistributed income as a distribution out of 
corpus and in that manner satisfied the requirements of this paragraph.
    Example 2. Assume the facts stated in example (1), except that X is 
a private college described in section 170(b)(1)(A)(ii) which is 
controlled by disqualified persons with respect to M and that the 
records which X furnishes to M show that the distribution would have 
been treated as made out of corpus if X were a private nonoperating 
foundation. Under these circumstances, result is the same as in example 
(1).
    Example 3. Assume the facts stated in example (1), except that X 
makes a distribution to the museum equal only to one-half of the 
contribution from M, that the remainder of such contribution is added to 
X's funds and used to pay charitable administrative expenses, and that 
the records obtained by M from X are not sufficient to show the amounts 
distributed or the identities of the recipients of the distributions. 
The contribution by M to X will be a qualifying distribution only to the 
extent that M can obtain (i) other sufficient evidence (such as 
statements from officers or employees of X or from the museum) showing 
the facts required by subparagraph (1)(ii) (a), (b), and (c) of this 
paragraph and (ii) a statement from X setting forth that the remainder 
of the contribution was used for charitable administrative expenses 
which constituted qualifying distributions described in paragraph 
(a)(2)(i) of this section.
    Example 4. X and Y are private nonoperating foundations. A is an 
exempt organization which is not described in section 501(c)(3) but 
which supervises and conducts a program described in section 
170(c)(2)(B). Y, but not X, controls A within the meaning of paragraph 
(a)(3) of this section. In 1972, X and Y each makes a grant to A of 
$100, specifically designated for use in the operation of A's section 
170(c)(2)(B) program. X has made a qualifying distribution to A because 
the distribution is one described in paragraph (a)(2)(i) of this 
section. However, because A is controlled by Y, Y's grant of $100 to A 
does not constitute a qualifying distribution within the meaning of such 
paragraph (a)(2)(i). Furthermore, because A is not an exempt 
organization described in section 501(c)(3), Y's grant to A does not 
constitute a qualifying distribution by operation of the provisions of 
this paragraph.

[[Page 105]]

    Example 5. N, a private nonoperating foundation, had distributable 
amounts of $100 in 1970 and $125 in 1971. In 1970 N received total 
contributions of $540: $150 from Y, a public charity; $70 from Z, a 
private foundation; $140 from Q, a private foundation, subject to the 
requirement that N earmark the amount and distribute it before 
distributing Z's contribution; and, $180 from R, also a private 
foundation. However, R specifically instructed N that such contribution 
did not have to be redistributed because R already had made enough 
qualifying distributions to avoid all section 4942 taxes. N is not 
controlled by Y, Z, Q, or R, and N made no qualifying distributions in 
1970. By the close of 1971, N had made qualifying distributions of $420, 
earmarking $140 as having been a distribution of Q's contribution, but 
had made no election under paragraph (d)(2) of this section to have any 
amount distributed which was in excess of N's 1970 undistributed income 
treated as distributed out of corpus. Therefore, the first $225 of 
qualifying distributions made in 1971 (the sum of $100 and $125, N's 
distributable amounts for 1970 and 1971, respectively) are treated as 
amounts described in paragraph (d)(1) (i) and (ii) of this section. 
Since Y's contribution is a contribution from a public charity and does 
not have to be ``redistributed'' and since R specifically instructed N 
that its contribution need not be ``redistributed'', the remaining $195 
of qualifying distributions will be treated as distributed pro rata from 
Z's and Q's contributions, regardless of N's earmarking. Accordingly, of 
Z's original qualifying distribution of $70 only $65 ($195 multiplied by 
$70, Z's contribution, over $210, the total ($70 plus $140) of Z's and 
Q's contributions) will be treated as redistributed by N. Similarly, of 
Q's original qualifying distribution of $140 only $130 ($195 multiplied 
by $140 over $210) will be treated as redistributed by N. Thus, Z's 
gross income for 1972 will be increased by $5 ($70 less the $65 actually 
redistributed), and Q's gross income for 1972 will be increased by $10 
($140 less the $130 actually redistributed).

    (4) Limitation. A contribution by a private foundation to a donee 
organization which the donee uses to make payments to another 
organization (the secondary donee) shall not be regarded as a 
contribution by the private foundation to the secondary donee if the 
distributing foundation does not earmark the use of the contribution for 
any named secondary donee and does not retain power to cause the 
selection of the secondary donee by the organization to which such 
foundation has made the contribution. For purposes of this subparagraph, 
a contribution described herein shall not be regarded as a contribution 
by the foundation to the secondary donee even though such foundation has 
reason to believe that certain organizations would derive benefits from 
such contribution so long as the original donee organization exercises 
control, in fact, over the selection process and actually makes the 
selection completely independently of such foundation.
    (5) Transitional rule. (i) For purposes of this paragraph, a 
contribution to a private foundation which is not an operating 
foundation and which is not controlled (directly or indirectly) by the 
distributing foundation or one or more disqualified persons with respect 
to the distributing foundation will be treated as a contribution to an 
operating foundation if:
    (a) Such contribution is made pursuant to a written commitment which 
was binding on May 26, 1969, and at all times thereafter.
    (b) Such contribution is made for one or more of the purposes 
described in section 170(c) (1) or (2)(B), and
    (c) Such contribution is to be paid out to the donee private 
foundation on or before December 31, 1974.
    (ii) For purposes of this subparagraph, a written commitment will be 
considered to have been binding prior to May 27, 1969, only if the 
amount and nature of the contribution and the name of the donee 
foundation were entered in the records of the distributing foundation, 
or were otherwise adequately evidenced, prior to May 27, 1969, or notice 
of the contribution was communicated in writing to such donee prior to 
May 27, 1969.
    (d) Treatment of qualifying distributions--(1) In general. Except as 
provided in subparagraph (2) of this paragraph, any qualifying 
distribution made during a taxable year shall be treated as made:
    (i) First out of the undistributed income (as defined in paragraph 
(a) of Sec. 53.4942(a)-2) of the immediately preceding taxable year (if 
the private foundation was subject to the initial excise tax imposed by 
section 4942(a) for such preceding taxable year) to the extent thereof;

[[Page 106]]

    (ii) Second out of the undistributed income for the taxable year to 
the extent thereof; and
    (iii) Then out of corpus.
    (2) Election. In the case of any qualifying distribution which 
(under subparagraph (1) of this paragraph) is not treated as made out of 
the undistributed income of the immediately preceding taxable year, the 
foundation may elect to treat any portion of such distribution as made 
out of the undistributed income of a designated prior taxable year or 
out of corpus. Such election must be made by filing a statement with the 
Commissioner during the taxable year in which such qualifying 
distribution is made or by attaching a statement to the return the 
foundation is required to file under section 6033 with respect to the 
taxable year in which such qualifying distribution was made. Such 
statement must contain a declaration by an appropriate foundation 
manager (within the meaning of section 4946(b)(1)) that the foundation 
is making an election under this subparagraph, and it must specify 
whether the distribution is made out of the undistributed income of a 
designated prior taxable year (or years) or is made out of corpus. In 
any case where the election described in this subparagraph is made 
during the taxable year in which the qualifying distribution is made, 
such election may be revoked in whole or in part by filing a statement 
with the Commissioner during such taxable year revoking such election in 
whole or in part or by attaching a statement to the return the 
foundation is required to file under section 6033 with respect to the 
taxable year in which the qualifying distribution was made revoking such 
election in whole or in part. Such statement must contain a declaration 
by an appropriate foundation manager (within the meaning of section 
4946(b)(1)) that the foundation is revoking an election under this 
subparagraph in whole or in part, and it must specify the election or 
part thereof being revoked.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a private foundation which was created in 1968 and 
which uses the calendar year as the taxable year, has distributable 
amounts and qualifying distributions for 1970 through 1976 as follows:

------------------------------------------------------------------------
                                           1970    1971    1972    1973
------------------------------------------------------------------------
Distributable amount....................    $100    $100    $100    $100
Qualifying distribution.................       0     100     250     100
                                         -------------------------------
                                            1974    1975    1976  ......
                                         -------------------------------
Distributable amount....................    $100    $100    $100  ......
Qualifying distribution.................     100     100     100  ......
------------------------------------------------------------------------

    In 1971 the qualifying distribution of $100 is treated under 
subparagraph (1)(i) of this paragraph as made out of the $100 of 
undistributed income for 1970. The qualifying distribution of $250 in 
1972 is treated as made: (i) $100 out of the undistributed income for 
1971 under subparagraph (1)(i) of this paragraph; (ii) $100 out of the 
undistributed income for 1972 under subparagraph (1)(ii) of this 
paragraph; and (iii) $50 out of corpus in 1972 under subparagraph 
(1)(iii) of this paragraph. The qualifying distribution of $100 in each 
of the years 1973 through 1976 is treated as made out of the 
undistributed income for each of those respective years under 
subparagraph (1)(ii) of this paragraph. See paragraph (e) of this 
section for rules relating to the carryover of qualifying distributions 
out of corpus.
    Example 2. M, a private foundation which uses the calendar year as 
the taxable year, has undistributed income of $300 for 1981, $200 for 
1982, and $400 for 1983. On January 14, 1983, M makes its first 
qualifying distribution in 1983 when it sets aside (within the meaning 
of paragraph (b) of this section) $700 for construction of a hospital. 
On February 24, 1983 a notice of deficiency with respect to the excise 
taxes imposed by section 4942 (a) and (b) in regard to M 's 
undistributed income for 1981 is mailed to M under section 6212(a). M 
notifies the Commissioner in writing on March 24, 1983, that it is 
making an election under subparagraph (2) of this paragraph to have its 
distribution of January 14th applied first against its undistributed 
income for 1982, next against its undistributed income for 1981, and 
last against its undistributed income for 1983. Thus, $200 of the $700 
qualifying distribution is treated as made out of the undistributed 
income for 1982; $300, out of undistributed income for 1981; and $200 
($700 less the sum of $200 and $300), out of the undistributed income 
for 1983. Thus, an initial excise tax of $45 (15 percent of $300) is 
imposed under section 4942(a). Since M made the election described 
above, the $300 (treated as distributed out of undistributed income for 
1981) corrects (within the meaning of section 4963(d)(2)) the taxable 
act because the undistributed income for 1981 is reduced to zero. 
Furthermore, correction is effected within the correction period (as 
defined in section 4963(e)(1) and Sec. 53.4963-1(e)). Therefore, under 
the provisions of section

[[Page 107]]

4961(a), the additional tax imposed by section 4942(b) will not be 
assessed.

    (e) Carryover of excess qualifying distributions--(1) In general. If 
in any taxable year for which an organization is subject to the initial 
excise tax imposed by section 4942(a) there is created an excess of 
qualifying distributions (as determined under subparagraph (2) of this 
paragraph), such excess may be used to reduce distributable amounts in 
any taxable year of the adjustment period (as defined subparagraph (3) 
of this paragraph). For purposes of section 4942, including paragraph 
(d) of this section, the distributable amount for a taxable year in the 
adjustment period shall be reduced to the extent of the lesser of (i) 
the excess of qualifying distributions made in prior taxable years to 
which such adjustment period applies or (ii) the remaining undistributed 
income at the close of such taxable year after applying any qualifying 
distributions made in such taxable year to the distributable amount for 
such taxable year (determined without regard to this paragraph). If 
during any taxable year of the adjustment period there is created 
another excess of qualifying distributions, such excess shall not be 
taken into account until any earlier excess of qualifying distributions 
has been completely applied against distributable amounts during its 
adjustment period.
    (2) Excess qualifying distributions. An excess of qualifying 
distributions is created for any taxable year beginning after December 
31, 1969, if:
    (i) The total qualifying distributions treated (under paragraph (d) 
of this section) as made out of the undistributed income for such 
taxable year or as made out of corpus with respect to such taxable year 
(other than amounts distributed by an organization in satisfaction of 
section 170(b)(1)(E)(ii) or paragraph (c) of this section, or applied to 
a prior taxable year by operation of the elections contained in 
paragraphs (c)(2)(iv) and (d)(2) of this section), exceeds
    (ii) The distributable amount for such taxable year (determined 
without regard to this paragraph).
    (3) Adjustment period. For purposes of this paragraph, the taxable 
years in the adjustment period are the 5 taxable years immediately 
following the taxable year in which the excess of qualifying 
distributions is created. Thus, an excess (within the meaning of 
subparagraph (2) of this paragraph) for any 1 taxable year cannot be 
carried over beyond the succeeding 5 taxable years. However, if during 
any taxable year in the adjustment period an organization ceases to be 
subject to the initial excise tax imposed by section 4942(a), any 
portion of the excess of qualifying distributions, which prior to such 
taxable year has not been applied against distributable amounts, may not 
be carried over to such taxable year or subsequent taxable years in the 
adjustment period, even if during any of such taxable years the 
organization again becomes subject to the initial excise tax imposed by 
section 4942(a).
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. (i) F, a private foundation which was created in 1967 and 
which uses the calendar year as the taxable year, has distributable 
amounts and qualifying distributions for 1970 through 1976 as follows:

------------------------------------------------------------------------
                  Year                     1970    1971    1972    1973
------------------------------------------------------------------------
Distributable amount....................    $100    $100    $100    $100
Qualifying distribution.................       0    $250     $70    $140
------------------------------------------------------------------------


------------------------------------------------------------------------
                  Year                     1974    1975    1976
------------------------------------------------------------------------
Distributable amount....................    $100    $100    $100  ......
Qualifying distribution.................     $60     $75    $105  ......
------------------------------------------------------------------------

    (ii) The qualifying distributions made in 1971 will be treated under 
paragraph (d) of this section as $100 made out of the undistributed 
income for 1970, then as $100 made out of the undistributed income for 
1971, and finally as $50 out of corpus in 1971. Since the total 
qualifying distributions for 1971 ($150) exceed the distributable amount 
for 1971 ($100), there exists a $50 excess of qualifying distributions 
which F may use to reduce its distributable amounts for the years 1972 
through 1976 (the taxable years in the adjustment period with respect to 
the 1971 excess). Therefore, the $100 distributable amount for 1972 is 
reduced by $30 (the lesser of the 1971 excess ($50) and the remaining 
undistributed income at the close of 1972 ($30), after the qualifying 
distributions of $70 for 1972 were applied to the original distributable 
amount for 1972 of $100). Since the distributable amount for 1972 was 
reduced to $70, there is no remaining undistributed income for 1972. 
Accordingly, the qualifying distributions made in 1973 will be treated 
as $100 made out

[[Page 108]]

of the undistributed income for 1973 and as $40 out of corpus in 1973. 
Since this amount ($140) exceeds the distributable amount for 1973 
($100), there exists a $40 excess which F may use to reduce its 
distributable amounts for the years 1974 through 1978 (the taxable years 
in the adjustment period with respect to the 1973 excess). However, in 
accordance with subparagraph (1) of this paragraph such excess may not 
be used to reduce F's distributable amounts for the years 1974 through 
1976 until the excess created in 1971 has been completely applied 
against distributable amounts during such years. The distributable 
amount for 1974 is reduced by $40 (the lesser of the unused portion of 
the 1971 excess ($20) plus the 1973 excess ($40) and the remaining 
undistributed income at the close of 1974 ($40), after the qualifying 
distributions of $60 for 1974 were applied to the original distributable 
amount for 1974 of $100). The distributable amount for 1975 is reduced 
by $20 (the lesser of the unused portion of the 1973 excess of 
qualifying distributions ($20) and the remaining undistributed income at 
the close of 1975 ($25), after the qualifying distributions of $75 for 
1975 were applied to the original distributable amount for 1975 of 
$100). Consequently, qualifying distributions made in 1976 will be 
treated as made first out of the $5 of remaining undistributed income 
for 1975 and then as $100 made out of the undistributed income for 1976.
    Example 2. Assume the facts as stated in example (1), except that in 
1974 F receives a contribution of $300 from G, a private foundation 
which controls F (within the meaning of paragraph (a)(3) of this 
section), and F distributes such contribution in 1975 in satisfaction of 
paragraph (c) of this section. Under these circumstances, there would be 
no excess of qualifying distributions for 1975 with respect to such 
distribution, since such distribution is excluded from the computation 
of an excess of qualifying distributions by operation of subparagraph 
(2)(i) of this paragraph.
    Example 3. Assume the facts as stated in example (1), except that in 
1972 F is treated as an operating foundation (as such term is defined in 
section 4942(j)(3)). In accordance with subparagraph (3) of this 
paragraph since F is not subject to the initial excise tax imposed by 
section 4942(a) for 1972, the 1971 excess cannot be carried forward to 
1972 or any subsequent year in the adjustment period with respect to the 
1971 excess, even if F is subsequently treated as a private nonoperating 
foundation for any year during the period 1973 through 1976.

[T.D. 7256, 38 FR 3323, Feb. 5, 1973, as amended by T.D. 7486, 42 FR 
24265, May 13, 1977; T.D. 7849, 47 FR 50857, Nov. 10, 1982; T.D. 7938, 
49 FR 3848, Jan. 31, 1984; T.D. 8084, 51 FR 16302, May 2, 1986]



Sec. 53.4942(b)-1  Operating foundations.

    (a) Operating foundation defined--(1) In general. For purposes of 
section 4942 and the regulations thereunder, the term ``operating 
foundation'' means any private foundation which, in addition to 
satisfying the assets test, the endowment test or the support test set 
forth in Sec. 53.4942(b)-2 (a), (b) and (c), makes qualifying 
distributions (within the meaning of Sec. 53.4942(a)-3(a)(2)) directly 
for the active conduct of activities constituting its charitable, 
educational, or other similar exempt purpose equal in value to:
    (i) For taxable years beginning before January 1, 1982, 
substantially all of the foundation's adjusted net income (as defined in 
Sec. 53.4942(a)-2(d)); and
    (ii) For taxable years beginning after December 31, 1981, 
substantially all of the lesser of the foundation's adjusted net income 
(as defined in Sec. 53.4942(a)-2(d)) or minimum investment return (as 
defined in Sec. 53.4942(a)-2(c)). If the foundation's qualifying 
distributions exceed its minimum investment return (but are less than 
the foundation's adjusted net income) substantially all of such 
qualifying distributions must be made directly for the active conduct of 
activities constituting its charitable, educational or other similar 
exempt purpose. However, if the foundation's minimum investment return 
is less than its adjusted net income and the foundation's qualifying 
distributions equal or exceed such adjusted net income, only that 
portion of the qualifying distributions equal to substantially all of 
the foundation's adjusted net income must be made directly for the 
active conduct of activities constituting its charitable, educational or 
other similar exempt purpose.
    (2) Certain elderly care facilities described in section 
4942(j)(6)--(i) In general. For purposes of the distribution 
requirements of section 4942 (but no other provision of the Internal 
Revenue Code) and for taxable years beginning after December 31, 1969, 
the term ``operating foundation'' includes a private foundation which:
    (A) On or before May 26, 1969, and continuously thereafter to the 
close of the taxable year, operates and maintains, as its principal 
functional purpose, residential facilities for the long-

[[Page 109]]

term care, comfort, maintenance, or education of permanently and totally 
disabled persons, elderly persons, needy widows, or children, and
    (B) Satisfies the endowment test set forth in Sec. 53.4942(b)-2 
(b).
    (ii) Principal functional purpose. For purposes of section 
4942(j)(6) and this subparagraph (2), an organization's ``principal 
functional purpose'' is operating and maintaining residential facilities 
for the long-term care, comfort, maintenance, or education of 
permanently and totally disabled persons, elderly persons, needy widows, 
or children, if it is organized for the principal purpose of operating 
and maintaining such residential facilities and is primarily engaged 
directly in the operation and maintenance of those facilities. An 
organization will be treated as being primarily engaged directly in the 
operation and maintenance of the described residential facilities if at 
least 50% of the qualifying distributions (as defined in Sec. 
53.4942(a)-3(a)(2)) normally made by the organization are expended for 
the operation and maintenance of the facilities.
    (b) Active conduct of activities constituting the exempt purpose--
(1) In general. For purposes of this section, except as provided in 
subparagraph (2) or (3) of this paragraph, qualifying distributions are 
not made by a foundation ``directly for the active conduct of activities 
constituting its charitable, educational, or other similar exempt 
purpose'' unless such qualifying distributions are used by the 
foundation itself, rather than by or through one or more grantee 
organizations which receive such qualifying distributions directly or 
indirectly from such foundation. Thus, grants made to other 
organizations to assist them in conducting activities which help to 
accomplish their charitable, educational, or other similar exempt 
purpose are considered an indirect, rather than direct, means of 
carrying out activities constituting the charitable, educational, or 
other similar exempt purpose of the grantor foundation, regardless of 
the fact that the exempt activities of the grantee organization may 
assist the grantor foundation in carrying out its own exempt activities. 
However, amounts paid to acquire or maintain assets which are used 
directly in the conduct of the foundation's exempt activities, such as 
the operating assets of a museum, public park, or historic site, are 
considered direct expenditures for the active conduct of the 
foundation's exempt activities. Likewise, administrative expenses (such 
as staff salaries and traveling expenses) and other operating costs 
necessary to conduct the foundation's exempt activities (regardless of 
whether they are ``directly for the active conduct'' of such exempt 
activities) shall be treated as qualifying distributions expended 
directly for the active conduct of such exempt activities if such 
expenses and costs are reasonable in amount. Conversely, administrative 
expenses and operating costs which are not attributable to exempt 
activities, such as expenses in connection with the production of 
investment income, are not treated as such qualifying distributions. 
Expenses attributable to both exempt and nonexempt activities shall be 
allocated to each such activity on a reasonable and consistently applied 
basis. Any amount set aside by a foundation for a specific project, such 
as the acquisition and restoration, or construction, of additional 
buildings or facilities which are to be used by the foundation directly 
for the active conduct of the foundation's exempt activities, shall be 
deemed to be qualifying distributions expended directly for the active 
conduct of the foundation's exempt activities if the initial setting 
aside of the funds constitutes a set-aside within the meaning of 
paragraph (b) of Sec. 53.4942(a)-3.
    (2) Payments to individual beneficiaries--(i) In general. If a 
foundation makes or awards grants, scholarships, or other payments to 
individual beneficiaries (including program related investments within 
the meaning of section 4944(c) made to individuals or corporate 
enterprises) to support active programs conducted to carry out the 
foundation's charitable, educational, or other similar exempt purpose, 
such grants, scholarships, or other payments will be treated as 
qualifying distributions made directly for the active conduct of exempt 
activities for purposes of paragraph (a) of this section only if the 
foundation, apart from the

[[Page 110]]

making or awarding of the grants, scholarships, or other payments, 
otherwise maintains some significant involvement (as defined in 
subdivision (ii) of this subparagraph) in the active programs in support 
of which such grants, scholarships, or other payments were made or 
awarded. Whether the making or awarding of grants, scholarships, or 
other payments constitutes qualifying distributions made directly for 
the active conduct of the foundation's exempt activities is to be 
determined on the basis of the facts and circumstances of each 
particular case. The test applied is a qualitative, rather than a 
strictly quantitative, one. Therefore, if the foundation maintains a 
significant involvement (as defined in subdivision (ii) of this 
subparagraph) it will not fail to meet the general rule of subparagraph 
(1) of this paragraph solely because more of its funds are devoted to 
the making or awarding of grants, scholarships, or other payments than 
to the active programs which such grants, scholarships, or other 
payments support. However, if a foundation does no more than select, 
screen, and investigate applicants for grants or scholarships, pursuant 
to which the recipients perform their work or studies alone or 
exclusively under the direction of some other organization, such grants 
or scholarships will not be treated as qualifying distributions made 
directly for the active conduct of the foundation's exempt activities. 
The administrative expenses of such screening and investigation (as 
opposed to the grants or scholarships themselves) may be treated as 
qualifying distributions made directly for the active conduct of the 
foundation's exempt activities.
    (ii) Definition. For purposes of this subparagraph, a foundation 
will be considered as maintaining a ``significant involvement'' in a 
charitable, educational, or other similar exempt activity in connection 
with which grants, scholarships, or other payments are made or awarded 
if:
    (A) An exempt purpose of the foundation is the relief of poverty or 
human distress, and its exempt activities are designed to ameliorate 
conditions among a poor or distressed class of persons or in an area 
subject to poverty or national disaster (such as providing food or 
clothing to indigents or residents of a disaster area), the making or 
awarding of the grants or other payments to accomplish such exempt 
purpose is direct and without the assistance of an intervening 
organization or agency, and the foundation maintains a salaried or 
voluntary staff of administrators, researchers, or other personnel who 
supervise and direct the activities described in this subdivision (A) on 
a continuing basis; or
    (B) The foundation has developed some specialized skills, expertise, 
or involvement in a particular discipline or substantive area (such as 
scientific or medical research, social work, education, or the social 
sciences), it maintains a salaried staff of administrators, researchers, 
or other personnel who supervise or conduct programs or activities which 
support and advance the foundation's work in its particular area of 
interest, and, as a part of such programs or activities, the foundation 
makes or awards grants, scholarships, or other payments to individuals 
to encourage and further their involvement in the foundation's 
particular area of interest and in some segment of the programs or 
activities carried on by the foundation (such as grants under which the 
recipients, in addition to independent study, attend classes, seminars, 
or conferences sponsored or conducted by the foundation, or grants to 
engage in social work or scientific research projects which are under 
the general direction and supervision of the foundation).
    (3) Payment of section 4940 tax. For purposes of section 4942(j)(3) 
(A) and (B)(ii), payment of the tax imposed upon a foundation under 
section 4940 shall be considered a qualifying distribution which is made 
directly for the active conduct of activities constituting the 
foundation's charitable, educational, or other similar exempt purpose.
    (c) Substantially all. For purposes of this section, the term 
``substantially all'' shall mean 85 percent or more. Thus, if a 
foundation makes qualifying distributions directly for the active 
conduct of activities constituting its charitable, educational, or other 
similar exempt purpose in an amount equal

[[Page 111]]

to at least 85 percent of its adjusted net income, it will be considered 
as satisfying the income test described in this section even if it makes 
grants to organizations or engages in other activities with the 
remainder of its adjusted net income and with other funds. In 
determining whether the amount of qualifying distributions made directly 
for the active conduct of such exempt activities equals at least 85 
percent of a foundation's adjusted net income, a foundation is not 
required to trace the source of such expenditures to determine whether 
they were derived from income or from contributions.
    (d) Examples. The provisions of this section may be illustrated by 
the following examples. It is assumed that none of the organizations 
described in these examples is described in section 509(a) (1), (2), or 
(3).

    Example 1. N, an exempt museum described in section 501(c)(3), was 
founded by the gift of an endowment from a single contributor. N uses 90 
percent of its adjusted net income to operate the museum. If N satisfies 
one of the tests set forth in Sec. 53.4942(b)-2 it may be classified as 
an operating foundation since substantially all of the qualifying 
distributions made by N are used directly for the active conduct of N's 
exempt activities within the meaning of paragraph (b)(1) of this 
section.
    Example 2. M, an exempt organization described in section 501(c)(3), 
was created to improve conditions in a particular urban ghetto. M 
receives its funds primarily from a limited number of wealthy 
contributors interested in helping carry out its exempt purpose. M's 
program consists of making a survey of the problems of the ghetto to 
determine the areas in which its funds may be applied most effectively. 
Approximately 10 percent of M's adjusted net income is used to conduct 
this survey. The balance of its income is used to make grants to other 
nonprofit organizations doing work in the ghetto in those areas 
determined to have the greatest likelihood of resulting in improved 
conditions. Under these circumstances, since only 10 percent of M's 
adjusted net income may be considered as constituting qualifying 
distributions made directly for the active conduct of M's exempt 
activities, M cannot qualify as an operating foundation.
    Example 3. Assume the facts as stated in example (2), except that M 
uses the remaining 90 percent of its adjusted net income for the 
following purposes: (1) M maintains a salaried staff of social workers 
and researchers who analyze its surveys and make recommendations as to 
methods for improving ghetto conditions; (2) M makes grants to 
independent social scientists who assist in these analyses and 
recommendations; (3) M publishes periodic reports indicating the results 
of its surveys and recommendations; (4) M makes grants to social workers 
and others who act as advisers to nonprofit organizations, as well as 
small business enterprises, functioning in the community (these advisers 
acting under the general direction of M attempt to implement M's 
recommendations through their advice and assistance to the nonprofit 
organizations and small business enterprises); and (5) M makes grants to 
other social scientists who study and report on the success of the 
various enterprises which attempt to implement M's recommendations. 
Under these circumstances, M satisfies the requirements of paragraph (b) 
(2) of this section, and the various grants it makes constitute 
qualifying distributions made directly for the active conduct of its 
exempt activities. Thus, if M satisfies one of the tests set forth in 
Sec. 53.4942(b)-2 it may be classified as an operating foundation.
    Example 4. P, an exempt educational organization described in 
section 501(c)(3), was created for the purpose of training teachers for 
institutions of higher education. Each year P awards a substantial 
number of fellowships to students for graduate study leading toward 
their M.A. or Ph. D. degrees. The applicants for these fellowships are 
carefully screened by P's staff, and only those applicants who indicate 
a strong interest in teaching in colleges or universities are chosen. P 
publishes and circulates various pamphlets encouraging a development of 
interest in college teaching and describing its fellowships. P also 
conducts annual summer seminars which are attended by its fellowship 
recipients, its staff, consultants, and other interested parties. The 
purpose of these seminars is to foster and encourage the development of 
college teaching. P publishes a report of the seminar proceedings along 
with related studies written by those who attended. Despite the fact 
that a substantial portion of P's adjusted net income is devoted to 
granting fellowships, its commitment to encouraging individuals to 
become teachers at institutions of higher learning, its maintenance of a 
staff and programs designed to further this purpose, and the granting of 
fellowships to encourage involvement both in its own seminars and in its 
exempt purpose indicate a significant involvement by P beyond the mere 
granting of fellowships. Thus, the fellowship grants made by P 
constitute qualifying distributions made directly for the active conduct 
of P's exempt activities within the meaning of paragraph (b) (2) of this 
section.
    Example 5. Q, an exempt organization described in section 501(c) 
(3), is composed of professional organizations interested in different 
branches of one academic discipline. Q

[[Page 112]]

trains its own professional staff, conducts its own program of research, 
selects research topics, screens and investigates grant recipients, 
makes grants to those selected, and sets up and conducts conferences and 
seminars for the grantees. Q has particular knowledge and skill in the 
given discipline, carries on activities to advance its study of that 
discipline, and makes grants to individuals to enable them to 
participate in activities which it conducts in carrying out its exempt 
purpose. Under these circumstances, Q's grants constitute qualifying 
distributions made directly for the active conduct of Q's exempt 
activities within the meaning of paragraph (b) (2) of this section.
    Example 6. R, an exempt medical research organization described in 
section 501 (c) (3), was created to study and perform research 
concerning heart disease. R has its own research center in which it 
carries on a broad number of research projects in the field of heart 
disease with its own professional staff. Physicians and scientists who 
are interested in special projects in this area present the plans for 
their projects to R. The directors of R study these plans and decide if 
the project is feasible and will further the work being done by R. If it 
is, R makes a grant to the individual to enable him to carry out his 
project, either at R's facilities or elsewhere. Reports of the progress 
of the project are made periodically to R, and R exercises a certain 
amount of supervision over the project. The resulting findings of these 
projects are usually published by R. Under these circumstances, the 
grants made by R constitute qualifying distributions made directly for 
the active conduct of R's exempt activities within the meaning of 
paragraph (b) (2) of this section.
    Example 7. S, an exempt organization described in section 501(c) 
(3), maintains a large library of manuscripts and other historical 
reference material relating to the history and development of the region 
in which the collection is located. S makes a limited number of annual 
grants to enable post-doctoral scholars and doctoral candidates to use 
its library. Sometimes S obtains the right to publish the scholar's 
work, although this is not a prerequisite to the receipt of a grant. The 
primary criterion for selection of grant recipients is the usefulness of 
the library's resources to the applicant's field of study. Under these 
circumstances, the grants made by S constitute qualifying distributions 
made directly for the active conduct of S's exempt activities within the 
meaning of paragraph (b) (2) of this section.
    Example 8. T, an exempt charitable organization described in section 
501(c)(3), was created by the members of one family for the purpose of 
relieving poverty and human suffering. T has a large salaried staff of 
employees who operate offices in various areas throughout the country. 
Its employees make gifts of food and clothing to poor persons in the 
area serviced by each office. On occasion, T also provides temporary 
relief in the form of food and clothing to persons in areas stricken by 
natural disasters. If conditions improve in one poverty area, T 
transfers the resources of the office in that area to another poverty 
area. Under these circumstances, the gifts of food and clothing made by 
T constitute qualifying distributions made directly for the active 
conduct of T's exempt activities within the meaning of paragraph (b) (2) 
of this section.
    Example 9. U, an exempt scientific organization described in section 
501(c) (3), was created for the principal purpose of studying the 
effects of early childhood brain damage. U conducts an active and 
continuous research program in this area through a salaried staff of 
scientists and physicians. As part of its research program, U awards 
scholarships to young people suffering mild brain damage to enable them 
to attend special schools equipped to handle such problems. The 
recipients are periodically tested to determine the effect of such 
schooling upon them. Under these circumstances, the scholarships awarded 
by U constitute qualifying distributions made directly for the active 
conduct of U's exempt activities within the meaning of paragraph (b) (2) 
of this section.
    Example 10. O, an exempt charitable organization described in 
section 501(c) (3), was created for the purpose of giving scholarships 
to children of the employees of X Corporation who meet the standards set 
by O. O not only screens and investigates each applicant to make sure 
that he complies with the academic and financial requirements set for 
scholarship recipients, but also administers an examination which each 
applicant must take--90 percent of O's adjusted net income is used in 
awarding these scholarships to the chosen applicants. O does not conduct 
any activities of an educational nature on its own. Under these 
circumstances, O is not using substantially all of its adjusted net 
income directly for the active conduct of its exempt activities within 
the meaning of paragraph (b) of this section. Thus, O is not an 
operating foundation because it fails to satisfy the income test set 
forth in paragraph (a) of this section.

[T.D. 7249, 38 FR 768, Jan. 4, 1973, as amended by T.D. 7718, 45 FR 
58520, Sept. 4, 1980; 46 FR 11254, Feb. 6, 1981; T.D. 7878, 48 FR 11943, 
Mar. 22, 1983]



Sec. 53.4942(b)-2  Alternative tests.

    (a) Assets test--(1) In general. A private foundation will satisfy 
the assets test under the provisions of this paragraph if substantially 
more than half of the foundation's assets:

[[Page 113]]

    (i) Are devoted directly (A) to the active conduct of activities 
constituting the foundation's charitable, educational, or other similar 
exempt purpose, (B) to functionally related businesses (as defined in 
paragraph (c)(3)(iii) of Sec. 53.4942(a)-2), or (C) to any combination 
thereof;
    (ii) Are stock of a corporation which is controlled by the 
foundation (within the meaning of section 368(c)) and substantially all 
the assets of which (within the meaning of paragraph (c) of Sec. 
53.4942(b)-1) are so devoted; or
    (iii) Are in part assets which are described in subdivision (i) of 
this subparagraph and in part stock which is described in subdivision 
(ii) of this subparagraph.
    (2) Qualifying assets--(i) In general. For purposes of subparagraph 
(1) of this paragraph, an asset is ``devoted directly to the active 
conduct of activities constituting the foundation's charitable, 
educational, or other similar exempt purpose'' only if the asset is 
actually used by the foundation directly for the active conduct of 
activities constituting its charitable, educational, or other similar 
exempt purpose. Thus, such assets as real estate, physical facilities or 
objects (such as museum assets, classroom fixtures and equipment, and 
research facilities), and intangible assets (such as patents, 
copyrights, and trademarks) will be considered qualifying assets for 
purposes of this paragraph to the extent they are used directly for the 
active conduct of the foundation's exempt activities. However, assets 
which are held for the production of income, for investment, or for some 
other similar use (for example, stocks, bonds, interest-bearing notes, 
endowment funds, or, generally, leased real estate) are not devoted 
directly to the active conduct of the foundation's exempt activities, 
even though the income derived from such assets is used to carry out 
such exempt activities. Whether an asset is held for the production of 
income, for investment, or for some other similar use rather than being 
used for the active conduct of the foundation's exempt activities is a 
question of fact. For example, an office building used for the purpose 
of providing offices for employees engaged in the management of 
endowment funds of the foundation is not devoted to the active conduct 
of the foundation's exempt activities. However, where property is used 
both for exempt purposes and for other purposes, if such exempt use 
represents 95 percent or more of the total use, such property shall be 
considered to be used exclusively for an exempt purpose. Property 
acquired by a foundation to be used in carrying out the foundation's 
exempt purpose may be considered as devoted directly to the active 
conduct of such purpose even though the property, in whole or in part, 
is leased for a limited period of time during which arrangements are 
made for its conversion to the use for which it was acquired, provided 
such income-producing use of the property does not exceed a reasonable 
period of time. Generally, 1 year shall be deemed to be a reasonable 
period of time for purposes of the immediately preceding sentence. 
Similarly, where property is leased by a foundation in carrying out its 
exempt purpose and where the rental income derived from such property by 
the foundation is less than the amount which would be required to be 
charged in order to recover the cost of purchase and maintenance of such 
property (taking into account the deductions permitted by paragraph 
(d)(4) of Sec. 53.4942(a)-2), such property shall be considered devoted 
directly to the active conduct of the foundation's exempt activities.
    (ii) Limitations. (A) Assets which are held for the purpose of 
extending credit or making funds available to members of a charitable 
class (including any interest in a program related-investment, except as 
provided in paragraph (b)(2) of Sec. 53.4942(b)-1) are not considered 
assets devoted directly to the active conduct of activities constituting 
the foundation's charitable, educational, or other similar exempt 
purpose. For example, assets which are set aside in special reserve 
accounts to guarantee student loans made by lending institutions will 
not be considered assets devoted directly to the active conduct of the 
foundation's exempt activities.
    (B) Any amount set aside by a foundation within the meaning of 
paragraph (b) (1) of Sec. 53.4942(b)-1 shall not be treated as an asset 
devoted directly to

[[Page 114]]

the active conduct of the foundation's exempt activities.
    (3) Assets held for less than a taxable year. For purposes of this 
paragraph, any asset which is held by a foundation for part of a taxable 
year shall be taken into account for such taxable year by multiplying 
the fair market value of such asset (as determined pursuant to 
subparagraph (4) of this paragraph) by a fraction, the numerator of 
which is the number of days in such taxable year that the foundation 
held such asset and the denominator of which is the number of days in 
such taxable year.
    (4) Valuation. For purposes of this paragraph, all assets shall be 
valued at their fair market value. Fair market value shall be determined 
in accordance with the rules set forth in paragraph (c)(4) of Sec. 
53.4942(a)-2, except in the case of assets which are devoted directly to 
the active conduct of the foundation's exempt activities and for which 
neither a ready market nor standard valuation methods exist (such as 
historical objects or buildings, certain works of art, and botanical 
gardens). In such cases, the historical cost (unadjusted for 
depreciation) shall be considered equal to fair market value unless the 
foundation demonstrates that fair market value is other than cost. In 
any case in which the foundation so demonstrates that the fair market 
value of an asset is other than historical cost, such substituted 
valuation may be used for the taxable year for which such new valuation 
is demonstrated and for each of the succeeding 4 taxable years if the 
valuation methods and procedures prescribed by paragraph (c)(4)(iv)(B) 
of Sec. 53.4942 (a)-2 are followed.
    (5) Substantially more than half. For purposes of this paragraph, 
the term substantially more than half shall mean 65 percent or more.
    (6) Examples. The provisions of this paragraph may be illustrated by 
the following examples. It is assumed that none of the organizations 
described in these examples is described in section 509(a) (1), (2), or 
(3).

    Example 1. W, an exempt organization described in section 501(c)(3), 
is devoted to the maintenance and operation of a historic area for the 
benefit of the general public. W has acquired and erected facilities for 
lodging and other visitor accommodations in such area, which W operates 
through a wholly owned, separately incorporated, taxable entity. These 
facilities comprise substantially all of the subsidiary's assets. The 
operation of such accommodations constitutes a functionally related 
business within the meaning of paragraph (c)(3)(iii) of Sec. 
53.4942(a)-2. Under these circumstances, the stock of the subsidiary 
will be considered as part of W's assets which may be taken into account 
by W in determining whether it satisfies the assets test described in 
this paragraph.
    Example 2. M, an exempt conservation organization described in 
section 501(c)(3), is devoted to acquiring, preserving, and otherwise 
making available for public use geographically diversified areas of 
natural beauty. M has acquired and erected facilities for lodging and 
other visitor accommodations in national park areas. The operation of 
such accommodations constitutes a functionally related business within 
the meaning of paragraph (c)(3)(iii) of Sec. 53.4942(a)-2. Therefore, 
M's assets which are directly devoted to such visitor accommodations may 
be taken into account by M in determining whether it satisfies the 
assets test described in this paragraph.
    Example 3. P, an exempt organization described in section 501(c)(3), 
is devoted to acquiring and restoring historic houses. To insure that 
the restored houses will be kept in the restored condition, and to make 
the houses more readily available for public display, P rents the houses 
rather than sells them once they have been restored. The rental income 
derived by P is substantially less than the amount which would be 
required to be charged in order to recover the cost of purchase, 
restoration, and maintenance of such houses. Therefore, such houses may 
be taken into account by P in determining whether it satisfies the 
assets test described in this paragraph.
    Example 4. Z, an exempt organization described in section 501(c)(3), 
is devoted to improving the public's understanding of Renaissance art. 
Z's principal assets are a number of paintings of this period which it 
circulates on an active and continuing basis to museums and schools for 
public display. These paintings constitute 80 percent of Z's assets. 
Under these circumstances, although Z does not have a building in which 
it displays these paintings, such paintings are devoted directly to the 
active conduct of activities constituting Z's exempt purpose. Therefore, 
Z has satisfied the assets test described in this paragraph.

    (b) Endowment test--(1) In general. A foundation will satisfy the 
endowment test under the provisions of this paragraph if it normally 
makes qualifying distributions (within the meaning of

[[Page 115]]

paragraph (a)(2) of Sec. 53.4942(a)-3) directly for the active conduct 
of activities constituting its charitable, educational, or other similar 
exempt purpose in an amount not less than two-thirds of its minimum 
investment return (as defined in paragraph (c) of Sec. 53.4942(a)-2). 
In determining whether the amount of such qualifying distributions is 
not less than an amount equal to two-thirds of the foundation's minimum 
investment return, the foundation is not required to trace the source of 
such expenditures to determine whether they were derived from investment 
income or from contributions.
    (2) Definitions. For purposes of this paragraph, the phrase directly 
for the active conduct of activities constituting the foundation's 
charitable, educational, or other similar exempt purpose shall have the 
same meaning as in paragraph (b) of Sec. 53.4942(b)-1.
    (3) Example. This paragraph may be illustrated by the following 
example:

    Example. X, an exempt organization described in section 501(c)(3) 
and not described in section 509(a) (1), (2), or (3), was created on 
July 15, 1970. X uses the cash receipts and disbursements method of 
accounting. For 1971, the fair market value of X's assets not described 
in paragraph (c) (2) or (3) of Sec. 53.4942(a)-2 is $400,000. X makes 
qualifying distributions for 1971 directly for the active conduct of its 
exempt activities of $17,000. For 1971 two-thirds of X's minimum 
investment return is $16,000 (6 percent x $400,000 = $24,000; \2/3\ x 
$24,000 = $16,000). Under these circumstances, X has satisfied the 
endowment test described in this paragraph for 1971. However, if X's 
qualifying distributions for 1971 directly for the active conduct of its 
exempt activities were only $15,000, X would not satisfy the endowment 
test for 1971, unless the fair market value of its assets not described 
in paragraph (c) (2) or (3) of Sec. 53.4942(a)-2 were no greater than 
$375,000 (6 percent x $375,000 = $22,500; \2/3\ x $22,500 = $15,000).

    (c) Support test--(1) In general. A foundation will satisfy the 
support test under the provisions of this paragraph if:
    (i) Substantially all of its support (other than gross investment 
income as defined in section 509(e)) is normally received from the 
general public and from five or more exempt organizations which are not 
described in section 4946(a)(1)(H) with respect to each other or the 
recipient foundation;
    (ii) Not more than 25 percent of its support (other than gross 
investment income) is normally received from any one such exempt 
organization; and
    (iii) Not more than half of its support is normally received from 
gross investment income.
    (2) Definitions and special rules. For purposes of this paragraph:
    (i) Support. The term support shall have the same meaning as in 
section 509(d).
    (ii) Substantially all. The term substantially all shall have the 
same meaning as in paragraph (c) of Sec. 53.4942(b)-1.
    (iii) Support from exempt organizations. The support received from 
any one exempt organization may be counted towards satisfaction of the 
support test described in this paragraph only if the foundation receives 
support from no fewer than five exempt organizations. For example, a 
foundation which normally receives 20 percent of its support (other than 
gross investment income) from each of five exempt organizations may 
qualify under this paragraph even though it receives no support from the 
general public. However, if a foundation normally received 10 percent of 
its support from each of three exempt organizations and the balance of 
its support from sources other than exempt organizations, such support 
could not be taken into account in determining whether the foundation 
had satisfied the support test set forth in this paragraph.
    (iv) Support from the general public. ``Support'' received from an 
individual, or from a trust or corporation (other than an exempt 
organization), shall be taken into account as support from the general 
public only to the extent that the total amount of the support received 
from any such individual, trust, or corporation during the period for 
determining the normal sources of the foundation's support (as set forth 
in Sec. 53.4942 (b)-3) does not exceed 1 percent of the foundation's 
total support (other than gross investment income) for such period. In 
applying this 1-percent limitation, all support received by the 
foundation from any person and from any other person or persons standing 
in a relationship to such person which is described in section 
4946(a)(1) (C)

[[Page 116]]

through (G) and the regulations thereunder shall be treated as received 
from one person. For purposes of this paragraph, support received from a 
governmental unit described in section 170(c)(1) shall be treated as 
support received from the general public, but shall not be subject to 
the 1-percent limitation.



Sec. 53.4942(b)-3  Determination of compliance with operating foundation
tests.

    (a) In general. A foundation may satisfy the income test and either 
the assets, endowment, or support test by satisfying such tests for any 
3 taxable years during a 4-year period consisting of the taxable year in 
question and the three immediately preceding taxable years or on the 
basis of an aggregation of all pertinent amounts of income or assets 
held, received, or distributed during such 4-year period. A foundation 
may not use one method for satisfying the income test described in 
paragraph (a) of Sec. 53.4942(b)-1 and another for satisfying either 
the assets, endowment, or support test described in Sec. 53.4942(b)-2. 
Thus, if a foundation satisfies the income test on the 3-out-of-4-year 
basis for a particular taxable year, it may not use the aggregation 
method for satisfying either the assets, endowment, or support test for 
such particular taxable year. However, the fact that a foundation has 
chosen one method for satisfying the tests under Sec. Sec. 53.4942(b)-1 
and 53.4942(b)-2 for 1 taxable year will not preclude it from satisfying 
such tests for a subsequent taxable year by the alternate method. If a 
foundation fails to satisfy the income test and either the assets, 
endowment, or support test for a particular taxable year under either 
the 3-out-of-4-year method or the aggregation method, it shall be 
treated as a nonoperating foundation for such taxable year and for all 
subsequent taxable years until it satisfies the tests set forth in 
Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 for a taxable year occurring 
after the taxable year in which it was treated as a nonoperating 
foundation.
    (b) New organizations--(1) In general. Except as provided in 
subparagraph (2) of this paragraph, an organization organized after 
December 31, 1969, will be treated as an operating foundation only if it 
has satisfied the tests set forth in Sec. Sec. 53.4942(b)-1 and 
53.4942(b)-2 for its first taxable year of existence. If an organization 
satisfies such tests for its 1st taxable year, it will be treated as an 
operating foundation from the beginning of such taxable year. If such is 
the case, the organization will be treated as an operating foundation 
for its 2d and 3d taxable years of existence only if it satisfies the 
tests set forth in Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 by the 
aggregation method for all such taxable years that it has been in 
existence.
    (2) Special rule. An organization organized after December 31, 1969, 
will be treated as an operating foundation prior to the end of its 1st 
taxable year if such organization has made a good faith determination 
that it is likely to satisfy the income test set forth in paragraph (a) 
of Sec. 53.4942(b)-1 and one of the tests set forth in Sec. 
53.4942(b)-2 for such 1st taxable year pursuant to subparagraph (1) of 
this paragraph. Such a ``good faith determination'' ordinarily will be 
considered as made where the determination is based on an affidavit or 
opinion of counsel of such organization that such requirements will be 
satisfied. Such an affidavit or opinion must set forth sufficient facts 
concerning the operations and support of such organization for the 
Commissioner to be able to determine that such organization is likely to 
satisfy such requirements. An organization which, pursuant to this 
subparagraph, has been treated as an operating foundation for its 1st 
taxable year, but actually fails to qualify as an operating foundation 
under subparagraph (1) of this paragraph for such taxable year, will be 
treated as a private foundation which is not an operating foundation as 
of the 1st day of its 2d taxable year for purposes of making any 
determination under the internal revenue laws with respect to such 
organization. The preceding sentence shall not apply if such 
organization establishes to the satisfaction of the Commissioner that it 
is likely to qualify as an operating foundation on the basis of its 2d, 
3d, and 4th taxable years. Thus, if such an organization fails to 
qualify as an operating foundation in its 2d, 3d, or 4th taxable year 
after having failed in its

[[Page 117]]

1st taxable year, it will be treated as a private foundation which is 
not an operating foundation as of the 1st day of such 2d, 3d, or 4th 
taxable year in which it fails to qualify as an operating foundation, 
except as otherwise provided by paragraph (d) of this section. Such 
status as a private foundation which is not an operating foundation will 
continue until such time as the organization is able to satisfy the 
tests set forth in Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 by either 
the 3-out-of-4-year method or the aggregation method. For the status of 
grants or contributions made to such an organization with respect to 
sections 170 and 4942, see paragraph (d) of this section.
    (c) Transitional rule for existing organizations. An organization 
organized before December 31, 1969 (including organizations deemed to be 
so organized by virtue of the principles of paragraph (e)(2) of Sec. 
53.4942(a)-2), but which is unable to satisfy the tests under Sec. Sec. 
53.4942(b)-1 and 53.4942(b)-2 for its first taxable year beginning after 
December 31, 1969 on the basis of its operations for taxable years prior 
to such taxable year by either the 3-out-of-4-year method or the 
aggregation method, will be treated as a new organization for purposes 
of paragraph (b) of this section only if:
    (1) The organization changes its methods of operation prior to its 
first taxable year beginning after December 31, 1972 to conform to the 
requirements of Sec. Sec. 53.4942(b)-1 and 53.4942 (b)-2;
    (2) The organization has made a good faith determination (within the 
meaning of paragraph (b) (2) of the section) that it is likely to 
satisfy the tests set forth in Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 
prior to its first taxable year beginning after December 31, 1972 on the 
basis of its income or assets held, received, or distributed during its 
taxable years beginning in 1970 through 1972; and
    (3) Such good faith determination is attached to the return the 
organization is required to file under section 6033 for its taxable year 
beginning in 1972.
    (d) Treatment of contributions--(1) In general. The status of grants 
or contributions made to an operating foundation with respect to 
sections 170 and 4942 will not be affected until notice of change of 
status of such organization is made to the public (such as by 
publication in the Internal Revenue Bulletin), unless the grant or 
contribution was made after:
    (i) The act or failure to act that resulted in the organization's 
inability to satisfy the requirements of Sec. Sec. 53.4942 (b)-1 and 
53.4942(b)-2, and the grantor or contributor was responsible for, or was 
aware of, such act or failure to act, or
    (ii) The grantor or contributor acquired knowledge that the 
Commissioner has given notice to such organization that it would be 
deleted from classification as an operating foundation.
    (2) Exception. For purposes of subparagraph (1) (i) of this 
paragraph, a grantor or contributor will not be considered to be 
responsible for, or aware of, the act or failure to act that resulted in 
the grantee organization's inability to satisfy the requirements of 
Sec. Sec. 53.4942 (b)-1 and 53.4942(b)-2 if such grantor or contributor 
has made his grant or contribution in reliance upon a written statement 
by the grantee organization that such grant or contribution would not 
result in the inability of such grantee organization to qualify as an 
operating foundation. Such a statement must be signed by a foundation 
manager (as defined in section 4946(b)) of the grantee organization and 
must set forth sufficient facts concerning the operations and support of 
such grantee organization to assure a reasonably prudent man that his 
grant or contribution will not result in the grantee organization's 
inability to qualify as an operating foundation.



               Subpart D_Taxes on Excess Business Holdings

    Authority: Secs. 4943 and 7805, Internal Revenue Code of 1954, 68A 
Stat. 917, 83 Stat. 507; 26 U.S.C. 4943, 7805.

    Source: T.D. 7496, 42 FR 46285, Sept. 15, 1977, unless otherwise 
noted.



Sec. 53.4943-1  General rule; purpose.

    Generally, under section 4943, the combined holdings of a private 
foundation and all disqualified persons (as defined in section 4946(a)) 
in any corporation conducting a business which is not substantially 
related (aside from the

[[Page 118]]

need of the foundation for income or funds or the use it makes of the 
profits derived) to the exempt purposes of the foundation are limited to 
20 percent of the voting stock in such corporation. In addition, the 
combined holdings of a private foundation and all disqualified persons 
in any unincorporated business (other than a sole proprietorship) which 
is not substantially related (aside from the need of the foundation for 
income or funds or the use it makes of the profits derived) to the 
exempt purposes of such foundation are limited to 20 percent of the 
beneficial or profits interest in such business. In the case of a sole 
proprietorship which is not substantially related (within the meaning of 
the preceding sentence), section 4943 provides that a private foundation 
shall have no permitted holdings. These general provisions are subject 
to a number of exceptions and special provisions which will be described 
in following sections.



Sec. 53.4943-2  Imposition of tax on excess business holdings of private 
foundations.

    (a) Imposition of initial tax--(1) In general--(i) Initial tax. 
Section 4943(a)(1) imposes an initial excise tax (the ``initial tax'') 
on the excess business holdings of a private foundation for each taxable 
year of the foundation which ends during the taxable period defined in 
section 4943(d)(2). The amount of such tax is equal to 5 percent of the 
total value of all the private foundation's excess business holdings in 
each of its business enterprises. In determining the value of the excess 
business holdings of the foundation subject to tax under section 4943, 
the rules set forth in Sec. Sec. 20.2031-1 through 20.2031-3 of this 
chapter (Estate Tax Regulations) shall apply.
    (ii) Disposition of certain excess business holdings within ninety 
days. In any case in which a private foundation acquires excess business 
holdings, other than as a result of a purchase by the foundation, the 
foundation shall not be subject to the taxes imposed by section 4943, 
but only if it disposes of an amount of its holdings so that it no 
longer has such excess business holdings within 90 days from the date on 
which it knows, or has reason to know, of the event which caused it to 
have such excess business holdings. Similarly, a private foundation 
shall not be subject to the taxes imposed by section 4943 because of its 
purchase of holdings where it did not know, or have reason to know of 
prior acquisitions by disqualified persons, but only if the foundation 
disposes of its excess holdings within the 90-day period described 
previously, and its purchase would not have created excess business 
holding but for such prior acquisitions by disqualified persons. In 
determining whether for purposes of this (ii) the foundation has 
disposed of such excess business holdings during such 90-day period, any 
disposition of holdings, by a disqualified person during such period 
shall be disregarded.
    (iii) Extension of ninety day period. The period described in 
paragraph (a)(1)(ii) of this section, during which no tax shall be 
imposed under section 4943, shall be extended to include the period 
during which a foundation is prevented by federal or state securities 
laws from disposing of such excess business holdings.
    (iv) Effect of disposition subject to material restrictions. If a 
private foundation disposes of an interest in a business enterprise but 
imposes any material restrictions or conditions that prevent the 
transferee from freely and effectively using or disposing of the 
transferred interest, then the transferor foundation will be treated as 
owning such interest until all such restrictions or conditions are 
eliminated (regardless of whether the transferee is treated for other 
purposes of the Code as owning such interest from the date of the 
transfer). However, a restriction or condition imposed in compliance 
with federal or state securities laws, or in accordance with the terms 
or conditions of the gift or bequest through which such interest was 
acquired by the foundation, shall not be considered a material 
restriction or condition imposed by a private foundation.
    (v) Foundation knowledge of acquisitions made by disqualified 
persons. (A) For purposes of paragraph (a)(1)(ii) of this section, 
whether a private foundation will be treated as knowing, or having 
reason to know, of the acquisition of holdings by a disqualified person

[[Page 119]]

will depend on the facts and circumstances of each case. Factors which 
will be considered relevant to a determination that a private foundation 
did not know or had no reason to know of an acquisition are: the fact 
that it did not discover acquisitions made by disqualified persons 
through the use of procedures reasonably calculated to discover such 
holdings; the diversity of foundation holdings; and the existence of 
large numbers of disqualified persons who have little or no contact with 
the foundation or its managers.
    (B) The provisions of paragraph (a)(1)(v)(A) of this section may be 
illustrated by the following example:

    Example. By the fifteenth day of the fifth month after the close of 
each taxable year, the F Foundation sends to each foundation manager, 
substantial contributor, person holding more than a 20% interest (as 
described in section 4946(a)(1)(C) in a substantial contributor, and 
foundation described in section 4946(a)(1)(H), a questionnaire asking 
such persons to list all holdings, actual or constructive, in each 
business enterprise in which F had holdings during the taxable year in 
excess of those permitted by the 2 percent de minimis rule of section 
4943(c)(2)(C). In preparing the list of such enterprises, F takes into 
account its constructive holdings only if, during the taxable year, F 
(along with all related foundations described in section 4946(a)(1)(H)) 
owned over 2% of the voting stock, profits interest or beneficial 
interest in the entity actually owning the holdings constructively held 
by F. The questionnaire asks each such person to list the holdings in 
such enterprises of any persons who, because of their relationship to 
such disqualified person, were themselves disqualified persons (i.e., 
members of the family (as defined in section 4946(d)), and any 
corporations, partnerships, trusts and estates described in section 
4946(a)(1) (E) through (G) in which such person, or members of his 
family, had an interest). The questionnaire asks that constructive 
holdings be listed only if, during the taxable year, the disqualified 
person owned over 2% of the voting stock, profits interest or beneficial 
interest in the entity actually owning the holdings constructively held 
by such person. (Thus a disqualified person owning less than 2% of a 
mutual fund is not required to list his attributed share of all the 
securities in the portfolio of the fund.) If no response to the 
questionnaire is received, the foundation seeks the information 
requested by the questionnaire by mailing a second (but not a third) 
questionnaire. If a questionnaire which is returned to the foundation 
indicates that certain information was unavailable to the person 
completing the questionnaire, the foundation seeks that information 
directly. For example, if a disqualified person indicates that he could 
not find out whether a corporation described in section 4946(a)(1)(E) 
had holdings in the enterprise listed in the questionnaire, the 
foundation seeks to obtain this information directly from the 
corporation by mailing it a questionnaire. In such a case F may be found 
not to have reason to know of the acquisition of holdings by a 
disqualified person.

    (vi) Holdings acquired other than by purchases. See section 
4943(c)(6) and Sec. 53.4943-6 for rules relating to the acquisition of 
certain holdings other than by purchase by the foundation or a 
disqualified person.
    (2) Special rules. In applying subparagraph (1) of this paragraph, 
the tax imposed by section 4943(a)(1):
    (i) Shall be imposed on the last day of the private foundation's 
taxable year, but
    (ii) The amount of such tax and the value of the excess business 
holdings subject to such tax shall be determined with respect to the 
foundation's holdings (based upon voting power, profits or beneficial 
interest, or value, whichever is applicable) in any business enterprise 
as of that day during the foundation's taxable year when the 
foundation's excess holdings in such enterprise were the greatest.

In applying subdivision (ii) of this subparagraph, if a foundation's 
excess business holdings in a business enterprise which constitute such 
foundation's greatest excess holdings in such enterprise for any taxable 
year are maintained for 2 or more days during such taxable year, the 
value of such excess holdings which is subject to tax under section 
4943(a)(1) shall be the greatest value of such excess holdings in such 
enterprise as of any day on which such greatest excess holdings are 
maintained during such taxable year.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. Y is a private foundation reporting on a calendar year 
basis. On January 1, 1973, Y has 20 shares of common stock in 
corporation N, of which five shares constitute excess business holdings. 
On June 1, 1973, Y

[[Page 120]]

disposes of such five shares; however, because of additional 
acquisitions of N common stock on such date by disqualified persons with 
respect to Y, the remaining 15 shares of N common stock held by Y now 
constitute excess business holdings. There are no further acquisitions 
or dispositions of N common stock during 1973 by Y or its disqualified 
persons. Although Y's greatest holdings in N during 1973 are held 
between January 1, 1973, and May 31, 1973, Y's greatest excess holdings 
in N during 1973 are held between June 1, 1973, and December 31, 1973. 
Therefore, the tax specified in section 4943(a)(1) shall be computed on 
the basis of the greatest value of such greatest excess holdings as of 
any day between June 1 and December 31, 1973.
    Example 2. X is a private foundation reporting on a calendar year 
basis. On January 1, 1972, X has 100 shares of common stock in M 
corporation which are excess business holdings. On such date each share 
of M common stock has a fair market value of $100. On February 28, 1972, 
in an effort to dispose of such excess business holdings, X sells 70 
shares of M common stock for $120 per share (the fair market value of 
each share on such date) to A, an individual who is not a disqualified 
person within the meaning of section 4946(a). The value of $120 per 
share is the highest fair market value between January 1 and February 
28, 1972. X disposes of no more stock in M for the reminder of calendar 
year 1972. On December 31, 1972, the fair market value of each share of 
M common stock is $80. X calculates its tax on its excess business 
holdings in M for 1972 as follows:

100 shares of M common stock times $120 fair market value        $12,000
 per share as of Feb. 28, 1972..............................
$12,000 multiplied by rate of tax (percent).................           5
Amount of tax on X foundation's excess business holdings for        $600
 1972.......................................................
 

    Example 3. Assume the same facts as in Example (2) except that the 
sale of X to A occurs on January 7, 1973, when the fair market value of 
each share of M corporation common stock equals $70. A value of $100 per 
share is the highest fair market value of the M common stock between 
January 1 and January 7, 1973. On may 9, 1973, X for the first time has 
excess business holdings in N corporation in the form of 200 shares of N 
common stock. The value per share of N common stock on May 9, 1973, 
equals $200. X makes no disposition of the N common stock during 1973, 
and the value of each share of N common stock as of December 31, 1973 
equals $250 (the highest value of N common stock during 1973). X 
calculates its tax on its excess business holdings in both M and N for 
1973 as follows:

100 shares of M common stock times $100 fair market value        $10,000
 per share..................................................
  $250 fair market value per share..........................     $50,000
    Total...................................................     $60,000
                                                             -----------
    Total...................................................     $60,000
$60,000 multiplied by rate of tax (percent).................           5
Amount of tax on X foundation's excess business holdings for      $3,000
 1973.......................................................
 

    (b) Additional tax. In any case in which the initial tax is imposed 
under section 4943(a) with respect to the holdings of a private 
foundation in any business enterprise, if, at the close of the taxable 
period (as defined in section 4943(d)(2) and Sec. 53.4943-9) with 
respect to such holdings the foundation still has excess business 
holdings in such enterprise, there is imposed a tax under section 
4943(b) equal to 200 percent of the value of such excess holdings as of 
the last day of the taxable period.

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 8084, 51 FR 
16302, May 2, 1986]



Sec. 53.4943-3  Determination of excess business holdings.

    (a) Excess business holdings--(1) In general. For purposes of 
section 4943, the term ``excess business holdings'' means, with respect 
to the holdings of any private foundation in any business enterprise (as 
described in section 4943(d)(4)), the amount of stock or other interest 
in the enterprise which, except as provided in Sec. 53.4943-2(a)(1), 
the foundation, or a disqualified person, would have to dispose of, or 
cause the disposition of, to a person other than a disqualified person 
(as defined in section 4946(a)) in order for the remaining holdings of 
the foundation in such enterprise to be permitted holdings (as defined 
in paragraphs (b) and (c) of this section). If a private foundation is 
required by section 4943 and the regulations thereunder to dispose of 
certain shares of a class of stock in a particular period of time and 
other shares of the same class of stock in a shorter period of time, any 
stock disposed of shall be charged first against those dispositions 
which must be made in such shorter period.
    (2) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. Corporation X has outstanding 100 shares of voting stock, 
with each share entitling the holder thereof to one vote. F, a private 
foundation, possesses 20 shares of X voting stock representing 20 
percent of the voting power in X. Assume that the permitted

[[Page 121]]

holdings of F in X under paragraph (b)(1) of this section are 11 percent 
of the voting stock in X. F, therefore, possesses voting stock in X 
representing a percentage of voting stock in excess of the percentage 
permitted by such paragraph. Such excess percentage is 9 percent of the 
voting stock in X, determined by subtracting the percentage of voting 
stock representing the permitted holdings of F in X (i.e., 11 percent) 
from the percentage of voting stock held by F in X (I.E., 20 percent). 
(20%-11%=9%). The excess business holdings of F in X are an amount of 
voting stock representing such excess percentage, or 9 shares of X 
voting stock (9 percent of 100).

    (b) Permitted holdings in an incorporated business enterprise--(1) 
In general--(i) Permitted holdings defined. Except as otherwise provided 
in section 4943(c) (2) and (4), the permitted holdings of any private 
foundation in an incorporated business enterprise (including a real 
estate investment trust, as defined in section 856) are:
    (A) 20 percent of the voting stock in such enterprise reduced (but 
not below zero) by
    (B) The percentage of voting stock in such enterprise actually or 
constructively owned by all disqualified persons.
    (ii) Voting stock. For purposes of this section, the percentage of 
voting stock held by any person in a corporation is normally determined 
by reference to the power of stock to vote for the election of 
directors, with treasury stock and stock which is authorized but 
unissued being disregarded. Thus, for example, if a private foundation 
holds 20 percent of the shares of one class of stock in a corporation, 
which class is entitled to elect three directors, and such foundation 
holds no stock in the other class of stock, which is entitled to elect 
five directors, such foundation shall be treated as holding 7.5 percent 
of the voting stock because the class of stock it holds has 37.5 percent 
of such voting power, by reason of being able to elect three of the 
eight directors, and the foundation holds one-fifth of the shares of 
such class (20 percent of 37.5 percent is 7.5 percent). The fact that 
extraordinary corporate action (e.g., charter or by-law amendments) by a 
corporation may require the favorable vote of more than a majority of 
the directors, or of the outstanding voting stock, of such corporation 
shall not alter the determination of voting power of stock in such 
corporation in accordance with the two preceding sentences.
    (2) Nonvoting stock as permitted holdings--(i) In general. In 
addition to those holdings permitted by paragraph (b)(1) of this 
section, the permitted holdings of a private foundation in an 
incorporated business enterprise shall include any share of nonvoting 
stock in such enterprise held by the foundation in any case in which all 
disqualified persons hold, actually or constructively, no more than 20 
percent (35 percent where third persons have effective control as 
defined in paragraph (b)(3)(ii) of this section) of the voting stock in 
such enterprise. All equity interests which do not have voting power 
attributable to them shall, for purposes of section 4943, the classified 
as nonvoting stock. For this purpose, evidences of indebtedness 
(including convertible indebtedness), and warrants and other options or 
rights to acquire stock shall not be considered equity interests.
    (ii) Stock with contingent voting rights and convertible nonvoting 
stock. Stock carrying voting rights which will vest only when 
conditions, the occurrence of which are indeterminate, have been met, 
such as preferred stock which gains such voting rights only if no 
dividends are paid thereon, will be treated as nonvoting stock until the 
conditions have occurred which cause the voting rights to vest. When 
such rights vest, the stock will be treated as voting stock that was 
acquired other than by purchase, but only if the private foundation or 
disqualified persons had no control over whether the conditions would 
occur. Similarly, nonvoting stock which may be converted into voting 
stock will not be treated as voting stock until such conversion occurs. 
For special rules where stock is acquired other than by purchase, see 
section 4943(c)(6) and the regulations thereunder.
    (iii) Example. The provisions of this pararaph (2) may be 
illustrated by the following example:

    Example. Assume that F, a private foundation, holds 10 percent of 
the single class of voting stock of corporation X, and owns 20

[[Page 122]]

shares of nonvoting stock in X. Assume further that A and B, the only 
disqualified persons with respect to F, hold 10 percent of the voting 
stock of X. Under the provisions of paragraph (b)(1) of this section the 
10 percent of X voting stock held by F will be classified as permitted 
holdings of F in X since 20 percent less the percentage of voting stock 
held by A and B in X is 10 percent. In addition, under the provisions of 
this (2), the 20 shares of X nonvoting stock will qualify as permitted 
holdings of F in X since the percentage of voting stock held by A and B 
in X is no greater than 20 percent.

    (3) Thirty-five-percent rule where third person has effective 
control of enterprise--(i) In general. Except as provided in section 
4943(c)(4), paragraph (b)(1) of this section shall be applied by 
substituting 35 percent for 20 percent if:
    (A) The private foundation and all disqualified persons together do 
not hold, actually or constructively, more than 35 percent of the voting 
stock in the business enterprise, and
    (B) The foundation establishes to the satisfaction of the 
Commissioner that effective control (as defined in paragraph (b)(3)(ii) 
of this section) of the business enterprise is in one or more persons 
(other than the foundation itself) who are not disqualfied persons.
    (ii) ``Effective control'' defined. For purposes of this 
subparagraph, the term ``effective control'' means the possession, 
directly or indirectly, of the power to direct or cause the direction of 
the management and policies of a business enterprise, whether through 
the ownership of voting stock, the use of voting trusts, or contractual 
arrangements, or otherwise. It is the reality of control which is 
decisive and not its form or the means by which it is exercisable. Thus, 
where a minority interest held by individuals who are not disqualified 
persons has historically elected the majority of a corporation's 
directors, effective control is in the hands of those individuals.
    (4) Two percent de minimis rule--(i) In general. Under section 
4943(c)(2)(C), a private foundation is not treated as having excess 
business holdings in any incorporated business enterprise in which it 
(together with all other private foundations (including trusts described 
in section 4947(a)(2)) which are described in section 4946(a)(1)(H)) 
actually or constructively owns not more than 2 percent of the voting 
stock and not more than 2 percent in value of all outstanding shares of 
all classes of stock. If, however, the private foundation, together with 
all other private foundations which are described in section 
4946(a)(1)(H), actually or constructively owns more than 2 percent of 
either the voting stock or the value of the outstanding shares of all 
classes of stock in any incorporated business enterprise, all the stock 
in such business enterprise classified as excess business holding under 
section 4943 is treated as excess business holdings. For purposes of 
this paragraph, any stock owned by a private foundation which is treated 
as held by a disqualified person under section 4943(c)(4)(B), (5), or 
(6) shall be treated as actually owned by the private foundation. See 
paragraph (b)(1) of Sec. 53.4941(d)-4 for the determination of excess 
business holdings without regard to section 4943(c)(2)(C) for purposes 
of applying section 101(C)(2)(B) of the Tax Reform Act of 1969 (83 Stat. 
533).
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. F, a private foundation, owns 1 percent of the single 
class of voting stock and 1 percent in value of all the outstanding 
shares of all classes of stock in X corporation. No other private 
foundation described in section 4946(a)(1)(H) owns any stock in X. All 
of the stock owned by F in X would be excess business holdings under 
section 4943 (c)(1) if section 4943(c)(2)(C) were inapplicable. F owns 
no no other shares of stock in X. Since F owns more than 2 percent of 
the voting stock and no more than 2 percent in value of all outstanding 
shares of all classes of stock in X, under section 4943(c)(2)(C) none of 
the stock in X owned by F is treated as excess business holdings.
    Example 2. Assume the facts as stated in Example (1), except that F 
and T, a controlled private foundation under section 4946 (a)(1)(H), 
together own 1 percent of all the voting stock and 1 percent in value of 
all the outstanding shares of all classes of stock in X. All of the 
stock in X owned by F and T would be excess business holdings under 
section 4943(c)(1) if section 4943(c)(2)(C) were inapplicable. Since F 
and T together owned no more than 2 percent of the voting stock and no 
more than 2 percent in value of all outstanding shares of all classes of 
stock in X, under section 4943(c)(2)(C) none of the stock in X owned by 
either F or T is treated as excess business holdings.

[[Page 123]]

    Example 3. Assume the facts as stated in Example (1), except that F 
owns 3 percent of the voting stock in X, 2 percent of which is treated 
as held by P, a disqualified person of F, under section 4943(c)(4)(B). 
Under subdivision (i) of this subparagraph, the 2 percent of the stock 
in X owned by F which is treated as held by P under section 
4943(c)(4)(B) is treated as actually owned by F for purposes of section 
4943(c)(2)(C). Consequently, all of the X stock owned by F is treated as 
excess business holdings under section 4943(c)(2)(C). However, only 1 
percent of the stock in X is subject to tax under section 4943(a), since 
the other 2 percent is treated as owned by a disqualified person under 
section 4943(c)(4)(B) for purposes of determining the tax upon F under 
section 4943(a).

    (c) Permitted holdings in an unincorporated business enterprise--(1) 
In general. The permitted holdings of a private foundation in any 
business enterprise which is not incorporated shall, subject to the 
provisions of subparagraphs (2), (3), and (4) of this paragraph, be 
determined under the principles of paragraph (b) of this section.
    (2) Partnership or joint venture. In the case of a partnership 
(including a limited partnership) or joint venture. the terms ``profits 
interest'' and ``capital interest'' shall be substituted for ``voting 
stock'' and ``nonvoting stock,'' respectively, wherever those terms 
appear in paragraph (b) of this section. The interest in profits of such 
foundation (or such disqualified person) shall be determined in the same 
manner as its distributive share of partnership taxable income. See 
section 704(b) (relating to the determination of the distributive share 
by the income or loss ratio) and the regulations thereunder. In the 
absence of a provision in the partnership agreement, the capital 
interest of such foundation (or such disqualified person) in a 
partnership shall be determined on the basis of its interest in the 
assets of the partnership which would be distributable to such 
foundation (or such disqualified person) upon its withdrawal from the 
partnership, or upon liquidation of the partnership, whichever is the 
greater.
    (3) Sole proprietorship. For purposes of section 4943, a private 
foundation shall have no permitted holdings in a sole proprietorship. In 
the case of a transfer by a private foundation of a portion of a sole 
proprietorship, see paragraph (c)(2) of this section (relating to 
permitted holdings in partnerships). For the treatment of a private 
foundation's ownership of a sole proprietorship prior to May 26, 1969, 
see Sec. 53.4943-4.
    (4) Trusts and other unincorporated business enterprises--(i) In 
general. In the case of any unincorporated business enterprise which is 
not described in paragraph (c) (2) or (3) of this section, the term 
``beneficial interest'' shall be substitued for ``voting stock'' 
wherever the term appears in paragraph (b) of this section. Any and all 
references to nonvoting stock in paragraph (b) of this section shall be 
inapplicable with respect to any unincorporated business enterprise 
described in this subparagraph.
    (ii) Trusts. For purposes of section 4943, the beneficial interest 
of a private foundation or any disqualified person in a trust shall be 
the beneficial remainder interest of such foundation or person 
determined as provided in paragraph (b) of Sec. 53.4943-8.
    (iii) Other unincorporated business enterprises. For purposes of 
section 4943, the beneficial interest of a private foundation or any 
disqualified person in an unincorporated business enterprise (other than 
a trust or an enterprise described in paragraph (c) (2) or (3) of this 
section) includes any right to receive a portion of distributions of 
profits of such enterprise, and, if the portion of distributions is not 
fixed by an agreement among the participants, any right to receive a 
portion of the assets (if any) upon liquidation of the enterprise, 
except as a creditor or employee. For purposes of this subparagraph, a 
right to receive distributions of profits includes a right to receive 
any amount from such profits (other than as a creditor or employee), 
whether as a sum certain or as a portion of profits realized by the 
enterprise. Where there is no agreement fixing the rights of the 
participants in such enterprise, the interest of such foundation (or 
such disqualified person) in such enterprise shall be determined by 
dividing the amount of all equity investments or contributions to the 
capital of the enterprise made or obligated to be made by such 
foundation (or such disqualified person) by the amount of all equity 
investments or contributions to capital made or obligated to be

[[Page 124]]

made by all participants in the enterprise.
    (d) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. Corporation X has outstanding 100 shares of voting stock, 
with each share entitling the holder thereof to one vote. Assume that F, 
a private foundation, possesses 30 shares of X voting stock, and that A 
and B, the only disqualified persons with respect to F, together own 10 
shares of X voting stock. The excess business holdings of F in X are 20 
shares of X voting stock, determined as follows:

(i) Determination of voting stock percentages
(a) Total number of outstanding votes in X..............             100
(b) Total number of votes in X held by F................              30
(c) Total number of votes in X held by A and B..........              10
(d) Percentage of voting stock in X held by F (item (b)               30
 divided by item (a)) (percent).........................
(e) Percentage of voting stock in X held by A and B                   10
 (item (c) divided by item (a)) (percent)...............
 
(ii) Determination of permitted holdings of voting stock
(a) Percentage of voting stock in X held by A and B                   10
 (percent)..............................................
(b) Permitted holdings of voting stock by F in X (20 pct              10
 less item (a)) (percent)...............................
 
(iii) Determination of excess business holdings
(a) Percentage of voting stock in X held by F (percent).              30
(b) Permitted holdings of voting stock by F in X                      10
 (percent)..............................................
(c) Item (a) less item (b) (percent)....................              20
(d) Excess business holdings of F in X (i.e., an amount               20
 of X voting stock representing a percentage of voting
 stock equivalent to that in item (c)) (shares).........
 
                              * * * * * * *
------------------------------------------------------------------------

    Example 2. F, a private foundation, is a partner in P partnership. 
In addition, A and B, the only disqualified persons with respect to F, 
are partners in P. The partnership agreement of P contains no provisions 
regarding the sharing of profits by, and the respective capital 
interests of, the partners.
    (i) assume that, under section 704(b), F's distributive share of P 
taxable income is determined to be 20 percent. In addition, assume that 
under such section, A and B are determined to have a 4-percent 
distributive share each of P taxable income. Accordingly, F holds a 20-
percent profits interest in P, and A and B hold an 8-percent profits 
interest in P. Assuming that the provisions of section 4943(c)(2)(B) do 
not apply, the permitted holdings of F in P are 12 percent of the 
profits interest in P, determined by subtracting the percentage of the 
profits interest held by A and B in P (i.e., 8 percent) from 20 percent. 
(20 percent-8 percent=12 percent.) F, therefore, holds a percentage of 
the profits interest in P in excess of the percentage permitted by Sec. 
53.4943-3(b)(1). The excess business holdings of F in P are a percentage 
of the profits interest in P equivalent to such excess percentage, or 8 
percent of the profits interest in P, determined by subtracting the 
permitted holdings of F in P (i.e., 12 percent) from the percentage of 
the profit interest held by F in P (i.e., 20 percent) (20 percent-12 
percent=8 percent.)
    (ii) Assume that, under the partnership agreement, F would be 
entitled to a distribution of 20 percent of P's assets upon F's 
withdrawal from P and to a distribution of 30 percent of P's assets upon 
the liquidation profits interest held by F in P (i.e., 20 percent) (20 
percent-12 percent=8 percent), of P. F, therefore, holds a 30-percent 
capital percentage of the assets of P distributable to F upon F's 
withdrawal from P, or the percentage of such assets distributable to F 
upon the liquidation of P. Since the percentage of the profits interest 
held by A and B in P is less than 20 percent, such 30-percent capital 
interest will be included in the permitted holdings of F in P.



Sec. 53.4943-4  Present holdings.

    (a) Introduction--(1) Section 4943 (c)(4) in general. (i) Paragraph 
(4) of section 4943(c) prescribes transition rules for a private 
foundation which, but for such paragraph, would have excess business 
holdings on May 26, 1969. Section 4943(c)(4) provides such a foundation 
with protection from the initial tax on excess business holdings in two 
ways. First, the entire interest of such a foundation in any business 
enterprise in which such a foundation, but for section 4943(c)(4), would 
have had excess business holdings on May 26, 1969, is treated under 
section 4943(c)(4)(B) as held by disqualified persons for a certain 
period of time (the ``first phase''). The effect of such treatment is to 
prevent a private foundation from being subject to the initial tax with 
respect to its May 26, 1969, interest during the first phase holding 
period and also to prevent the foundation from purchasing any additional 
business holdings in such business enterprise during

[[Page 125]]

such period (unless the combined holdings of the foundation and all 
disqualified persons fall below the 20 percent (or 35 percent, if 
applicable) figure prescribed by section 4943(c)(2)). Second, section 
4943(c)(4)(A)(i) initially increases the percentage of permitted 
holdings of such a foundation to a percentage equal to the difference 
between:
    (A) The percentage of combined holdings of the foundation and all 
disqualified persons in such business enterprise on May 26, 1969 
(subject to a 50 percent maximum), and
    (B) The percentage of holdings of all disqualified persons.

The percentage referred to in paragraph (a)(1)(i)(A) of this section is 
referred to in this section as the ``substituted level''. This 
``substituted level'' is then reduced by the ``downward ratchet rule'' 
prescribed by section 4943(c)(4)(A)(ii) and paragraph (d)(3) of this 
section for certain dispositions by such foundation or by disqualified 
persons. The primary purpose of the substituted level is to indicate 
what the permitted holdings in such business enterprise will be 
immediately after the expiration of the first phase holding period. 
Thereafter, the permitted holdings of a private foundation itself are 
further limited to a maximum 25 percent interest in such business 
enterprise by section 4943(c)(4)(D) as soon as the combined holdings of 
all disqualified persons in such business enterprise exceed 2 percent 
(of the voting stock). If the combined holdings of all disqualified 
persons at no time exceed 2 percent (of the voting stock) during the 15 
years following the first phase (the ``second phase''), then the 
substituted level is reduced to a 35 percent maximum after the second 
phase.
    (ii) Paragraph (a)(1)(i) of this section may be illustrated by the 
following example:

    Example. On May 26, 1969, private foundation P held a 5 percent 
interest in corporation X (voting stock and value). On such date 
disqualified persons held a 16 percent interest in X (voting stock and 
value). Assume that except for section 4943(c)(4), P would have had a 1 
percent interest in X which would have consitituted excess business 
holdings. Therefore, section 4943(c)(4)(B) applies and P's 5 percent 
interest in X is treated as held by a disqualified person during the 10-
year period beginning May 26, 1969. Since the entire 21 percent held by 
P and disqualified persons is now treated as held by disqualified 
persons, P's substituted level is 21 percent and its permitted holdings 
are zero (21%-21%). However, P has no excess business holdings in X, 
because during the 10-year period P is not treated as holding such 
interest. The only change in the interest in X occurs on January 2, 
1972, when P disposes of 2 percent of its interest in X to A, an 
unrelated person. Since the interest held by P and all disqualified 
persons (21%-2%=19%) has decreased below 20 percent, P's substituted 
level is reduced to 20 percent and its permitted holdings are 1 percent 
(20%-19%) on such date. Therefore, if the other interests in X do not 
change, P will not have excess business holdings if P purchases no more 
than an additional 1 percent interest in X.

    (2) Interaction of provisions of section 4943(c) (4), (5), and (6). 
During the first phase, a private foundation may acquire additional 
interests in a business enterprise, other than by purchase, which are 
entitled to be treated as held by disqualified persons for varying 
holding periods under section 4943(c) (5) or (6) (relating respectively 
to certain holdings acquired pursuant to the terms of a trust or will in 
effect on May 26, 1969, and to the 5-year period to dispose of certain 
gifts, bequests, etc.). In any case holdings which the private 
foundation disposes of shall be charged first against those holdings 
which it must dispose of in the shortest period in order to avoid the 
initial tax thereon. Further, acquisions of a private foundation under a 
pre-May 27, 1969, will or trust described in section 4943(3)(5) are 
treated in a manner similar to the treatment of interests actually held 
by a private foundation on May 26, 1969. See Sec. Sec. 53.4943-5 and 
53.4943-6.
    (b) Present holdings in general. (1) Section 4943(c)(4)(B) provides 
that any interest in a business enterprise held by a private foundation 
on May 26, 1969, if the foundation on such date has excess business 
holdings (determined without regard to section 4943(c)(4)), shall (while 
held by the foundation) be treated as held by a disqualified person 
during a first phase. Therefore, no interest of a private foundation 
shall be treated as held by a disqualified person under section 
4943(c)(4)(B) and this section unless:

[[Page 126]]

    (i) The private foundation was an entity (not including a revocable 
trust) in existence on May 26, 1969, even though it was not then treated 
as a private foundation under section 509 or section 4947;
    (ii) Such interest was actually or constructively owned by such 
entity on such date; and
    (iii) Without regard to section 4943(c)(4) such entitly had on such 
date an interest (considered in connection with the interests actually 
or constructively owned by all disqualified persons with respect to such 
entity on that date in the same business enterprise, determined as if 
the entity were then a private foundation) which exceeded the permitted 
holdings prescribed by section 4943(c) (2) or (3).

(See, however, section 4943(c)(5) and Sec. 53.4943-5 for similar 
treatment for certain interests acquired by a private foundation under 
the terms of a trust or a will which were in effect on May 26, 1969.) If 
a private foundation owns an interest described by section 
4943(c)(4)(B), then the length of the first phase for such an interest 
is prescribed by paragraph (c) of this section and shall not be affected 
by any interest acquired by the private foundation or any disqualified 
person in such business enterprise after May 26, 1969. In addition, the 
amount of permitted holdings in such business enterprise is prescribed 
by paragraph (d) of this section. An interest constructively held by a 
private foundation (or a disqualified person) on May 26, 1969, shall not 
cease to be an interest to which section 4943(c)(4) applies merely 
because it is later distributed to such foundation (or to such 
disqualified person). Nor shall an interest directly held by a private 
foundation (or to such disqualified person) on May 26, 1969, cease to be 
treated as an interest to which section 4943(c)(4) applies to the extent 
it remains actually or constructively held by such foundation (or such 
disqualified person) upon transfer of such interest, such as upon the 
incorporation of a sole proprietorship.
    (2) The provision of this paragraph may be illustrated by the 
following example:

    Example. A, a nonprofit research organization described in section 
501(c)(3), was organized in 1966. On May 26, 1969, A held 50 percent of 
the stock of corporation B. For its taxable years 1970, 1971, and 1972, 
A is classified as an organization described in section 509(a)(2). 
However, for 1973 and subsequent years, A fails to satisfy the gross 
investment income limitation of section 509(a)(2)(B), and is thus 
classified as a private foundation. In such a case, section 4943(c)(4) 
applies, and a disqualified person shall be treated as holding A's stock 
in B during a first phase that begins on May 26, 1969.

    (c) First Phase holding periods--(1) In general. If, on May 26, 
1969, a private foundation has excess business holdings in any business 
enterprise (determined with regard to the 20 or 35 percent permitted 
holdings of section 4943(c)(2)), then all interest which such foundation 
holds, actually or constructively, in such enterprise on May 26, 1969, 
shall (while held by such foundation) be deemed held by a disqualified 
person during the following periods:
    (i) The 20-year period beginning on May 26, 1969, if the private 
foundation holds, actually or constructively, more than 95 percent of 
the voting stock (or more than a 95 percent profits or beneficial 
interest in the case of an unincorporated enterprise) in such enterprise 
on such date;
    (ii) Except as provided in paragraph (c)(1)(i) of this section, the 
15-year period beginning on May 26, 1969, if the private foundation and 
all disqualified persons hold, actually or constructively on such date 
more than 75 percent of the voting stock (or more than a 75 percent 
profits or beneficial interest in the case of any unincorporated 
enterprise) or 75 percent of the value of all outstanding shares of all 
classes of stock in such enterprise (or more than a 75 percent profits 
and capital interest in the case of a partnership or joint venture); or
    (iii) The 10-year period beginning on May 26, 1969, in any case not 
described in paragraph (c)(1) (i) or (ii) of this section.

The 20-year, 15-year, or 10-year period described in this subdivision 
(whichever applies) shall, for purposes of section 4943 and this 
section, be known as the ``first phase.''
    (2) Sole proprietorships. The 20-year period described in paragraph 
(c)(1) of this section shall apply with respect to

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any interest which a private foundation holds in a sole proprietorship 
on May 26, 1969. See paragraph (b) of this section for the effect of 
converting such an enterprise to a corporate, partnership, or other 
form.
    (3) Suspension of first-phase periods. The 20-year, 15-year, or 10-
year period described in paragraph (c)(1) of this section shall be 
suspended during the dependency of any judicial proceeding which is 
brought and diligently litigated by the private foundation and which is 
necessary to reform, or to excuse the foundation from compliance with, 
its governing instrument or any other instrument (as in effect on May 
26, 1969) in order to allow disposition of any excess business holdings 
held by the foundation on May 26, 1969.
    (4) Election to shorten the period during which certain holdings of 
private foundations are treated as held by disqualified persons. If, on 
May 26, 1969, the combined holdings of a private foundation and all 
disqualified persons in any one business enterprise are such as to make 
applicable the 15-year period referred to in paragraph (c)(1)(ii) of 
this section, and if, on such date, the foundation's holdings do not 
exceed 95 percent of the voting stock in such enterprise, then such 15-
year period is shortened to the 10-year period referred to in paragraph 
(c)(1)(iii), if at any time before January 1, 1971, one or more 
individuals:
    (i) Who are substantial contributors (as described in section 
507(d)(2)), or members of the family within the meaning of section 
4946(d) of one or more substantial contributors, to such private 
foundation, and
    (ii) Who on May 26, 1969, held in the aggregate more than 15 percent 
of the voting stock in the enterprise, made an election in the manner 
described in 26 CFR 143.6 (rev. as of Apr. 1, 1974).
    (5) Examples. The provisions of this paragraph (c) may be 
illustrated by the following examples:

    Example 1. Assume that F, a private foundation, owns, on May 26, 
1969, 50 shares of voting stock in corporation X respresenting 50 
percent of the voting power in X and 25 percent of the value of all 
outstanding shares of all classes of stock in X. Assume further that A 
and B, the only disqualified persons with respect to F, own five shares 
each of voting stock in X on such date. The 10 shares of voting stock in 
X owned by A and B together represent 10 percent of the voting power in 
X and 5 percent of the value of all outstanding shares of all classes of 
stock in X. Under the provisions of Sec. 53.4943-3, the excess business 
holdings of F, in X (determined without regard to section 4943(c)(4)) as 
of such date are, therefore, 40 percent of X voting stock. Accordingly, 
since the combined holdings of F, A, and B in X are, on such date, less 
than 75 percent of the voting stock in X and less than 75 percent of the 
value of all outstanding shares of all classes of stock in X, under the 
provisions of section 4943(c)(4)(B)(iii), all holdings of F in X (i.e., 
50 percent of X voting stock) will be treated as held by a disqualified 
person through May 25, 1979.
    Example 2. Assume the facts as stated in Example (1), except that F, 
on December 15, 1969, purchases an additional 10 shares of voting stock 
in X representing 10 percent of X voting power. Assume, further, that 
there were no other transactions in the stock in X during 1969. While 
the 50 percent of X voting stock held by F on May 26, 1969, will be 
deemed held by a disqualified person through May 25, 1979, the 
additional 10 shares of X voting stock acquired by purchase by F on 
December 15, 1969, will no be deemed to be so held. Accordingly, since, 
under the provisions of Sec. 53.4943-3, such 10 shares represent excess 
business holding of F in X, such 10 shares will be subject to the 
imposition of tax under the provisions of section 4943(a).
    Example 3. Assume the facts as stated in Example (1), except that F, 
on December 15, 1971 acquires an additional 10 shares of voting stock in 
X (representing 10 percent of X voting power) under the terms of a will 
which was executed before May 26, 1969, to which section 4943(c)(5) 
applies. While the 50 percent of X voting stock held by F on May 26, 
1969, will be deemed held by a disqualified person through May 25, 1979, 
the additional 10 percent of X voting stock acquired by F on December 
15, 1971, will, under the provisions of section 4943(c)(5), be deemed 
held by a disqualified person through December 14, 1981. See Sec. 
53.4943-5.
    Example 4. Assume that F, a private foundation, owns on May 26, 
1969, 50 shares of voting stock in corporation Y representing 50 percent 
of the voting power in Y. Assume further that C and D, the only 
disqualified persons with respect to F, own on such date 15 shares each 
of Y voting stock and that the 30 shares of Y voting stock owned by C 
and D together represent 30 percent of the voting power in Y. Under the 
provisions of Sec. 53.4943-3 the excess business holdings of F in Y 
(determined without regard to section 4943(c)(4)) as of such date are, 
therefore, 50 percent of Y voting stock. Accordingly, since the combined 
holdings of F, C, and D in Y represent, on such date, more than 75 
percent of the voting stock in Y, under the provisions of section 
4943(c)(4)(B)(ii), all holdings of F in Y

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(i.e., 50 percent of Y voting stock will be treated as held by a 
disqualified person through May 25, 1984.
    Example 5. M, a private foundation, owns on May 26, 1969, sole 
proprietorship S. Since, under the provisions of Sec. 53.5954-3, M's 
ownership of S constitutes excess business holdings (determined without 
regard to section 4943(c)(4) as of May 26, 1969, and since M's interest 
in S is greater than 95 percent on such date, under the provisions of 
this paragraph a disqualified person will be treated as the owner of S 
for the 20-year period beginning on such date. If S is later 
incorporated, that percentage of the interest in S retained by M, even 
though less than a 95-percent interest, shall continue to be treated as 
held by a disqualified person through May 25, 1989.
    Example 6. A and B, individuals, together own on May 26, 1969, 40 
shares of voting stock in corporation X representing 40 percent of the 
voting power in X and 20 percent of the value of all outstanding shares 
of all classes of stock in X. A and B are both disqualified persons with 
respect to F, a private foundation, which owns no stock in X on May 26, 
1969. On January 1, 1973, A and B donate the 40 shares of X voting stock 
held by them to F. Since F had no excess business holdings on May 26, 
1969, section 4943(c)(4) does not apply. See however, section 4943(c)(6) 
and Sec. 53.4943-6.
    Example 7. Assume the facts as stated in Example (6), except that F, 
on May 26, 1969, owns 50 shares of voting stock in X, representing 50 
percent of the voting power in X and 25 percent of the value of all 
outstanding shares of all classes of stock in X. Under the provisions of 
this paragraph, the 50 shares of X voting stock held by F on May 26, 
1969 shall be treated in accordance with the provisions of section 
4943(c)(4), while the 40 shares of X voting stock acquired by F on 
January 1, 1973 shall be treated in accordance with the provisions of 
section 4943(c)(6). See Sec. 53.4943-6.

    (d) Permitted holdings under section 4943(c)(4)--(1) In general. The 
permitted holdings of a private foundation to which section 4943 (c)(4) 
applies in a business enterprise shall be as follows:
    (i) The excess of the substituted combined voting level over the 
disqualified person voting level, and separately,
    (ii) The excess of the substituted combined value level over the 
disqualified person value level.
    (2) Definitions. For purposes of paragraph (d) of this section:
    (i) The term disqualified person voting level on any given date 
means the percentage of voting stock held by all disqualified persons 
together on such date (including stock deemed held by such a person by 
reason of section 4943(c)(4), (5), or (6)).
    (ii) The term disqualified person value level on any given date 
means the percentage of the total value of all outstanding shares of all 
classes of stock in a business enterprise held by all disqualified 
persons together on such date (including stock deemed held by such a 
person by reason of section 4943(c)(4), (5), or (6)).
    (iii) The term foundation voting level prior to the second phase is 
equal to zero. After the first phase, such term on any given date means 
the lowest percentage of voting stock held by a private foundation 
(without regard to section 4943(c)(4)(B)) in a business enterprise on 
May 26, 1969, and at all times thereafter up to such date. See section 
4943(c)(5) and Sec. 53.4943-5 for the effect of the interests acquired 
pursuant to the terms of certain wills or trusts in effect on May 26, 
1969.
    (iv) The term foundation value level prior to the second phase is 
equal to zero. After the first phase, such term on any given date means 
the lowest percentage of the total value of all outstanding shares of 
all classes of stock held by a private foundation (without regard to 
section 4943(c)(4)(B)) in a business enterprise on May 26, 1969, and at 
all times thereafter up to such date. See section 4943(c)(5) and Sec. 
53.4943-5 for the effect of interests acquired pursuant to the terms of 
certain wills or trusts in effect on May 26, 1969.
    (v) The term substituted combined voting level means the lowest 
percentage to which the sum of the foundation voting level plus the 
disqualified person voting level has been reduced since May 26, 1969, by 
paragraph (d)(4) of this section to the following modifications (the 
``downward ratchet rule''), subject;
    (A) In no event shall such substituted level exceed 50 percent; and
    (B) Such substituted level shall be increased (but not above 50 
percent) in accordance with section 4943(c)(5) and Sec. 53.4943-5 for 
certain interests acquired by such foundation pursuant to the terms of a 
will or trust in effect on May 26, 1969.
    (vi) The term substituted combined value level means the lowest 
percentage to which the sum of the foundation value level plus the 
disqualified person

[[Page 129]]

value level has been reduced since May 26, 1969, by paragraph (d)(4) of 
this section (the ``downward ratchet rule''), subject to the following 
modifications:
    (A) In no event shall such substituted level exceed 50 percent; and
    (B) Such substituted level shall be increased (but not above 50 
percent) in accordance with section 4943(c)(5) and Sec. 53.4943-5 for 
certain interests acquired by such foundation pursuant to the terms of a 
will or trust in effect on May 26, 1969.
    (vii) In the case of an interest in a partnership or joint venture, 
definitions (i) through (iv) of this subparagraph shall be applied by 
substituting ``profit interests'' for ``voting stock'' and ``all 
partnership interests'' for ``all outstanding shares of all classes of 
stock.''
    (viii) In the case of an interest in a business enterprise other 
than a corporation, partnership or joint venture, definitions (i) 
through (iv) of this subparagraph shall be applied by substituting 
``beneficial remainder interests'' for ``voting stock'' and ``all 
beneficial remainder interests'' and ``all outstanding shares of all 
classes of stock.''
    (ix) Each level defined in paragaph (d)(2)(iii), (iv) and (v) and 
(vi) as of any date shall be carried over to the subsequent date subject 
to any adjustments prescribed for such level.
    (3) Permitted holdings--First phase. Since during the first phase 
the substituted combined voting level generally does not exceed the 
disqualified person voting level, and the substituted combined value 
level generally does not exceed the disqualified person value level, the 
permitted holdings during the first phase are generally equal to zero. 
The permitted holdings during the first phase exceed zero only where the 
20 percent (or 35 percent) limitation on the downward ratchet rule 
contained in paragraph (d)(4)(ii)(B) of this section applies.
    (4) Downward ratchet rule--(i) In general. Except as provided in 
paragraph (d)(4)(ii) of this section and section 4943(c)(5):
    (A) Scope of rule. In general, when the percentage of the holdings 
in a business enterprise held by a private foundation and all 
disqualified persons together to which section 4943(c)(4) applies 
decreases, or when the percentage of the holdings of the private 
foundation alone in such business enterprise decreases, such holdings 
may not be increased (except as provided under section 4943(c) (5) or 
(6)). This so-called ``downward ratchet rule'' is designed to prevent 
the private foundation from purchasing additional holdings in the 
business enterprise until the substituted combined voting level reduced 
to the 20-percent (or 35 percent) figure prescribed by section 
4943(c)(2).
    (B) Levels affected. Under the downward ratchet rule any decrease 
after May 26, 1969, in the percentage of holdings comprising either the 
substituted combined voting level, the substituted combined value level, 
the foundation voting level or the foundation value level shall cause 
the respective level to be decreased to such decreased percentage for 
purposes of determining the foundation's permitted holdings.
    (C) Implementation of reductions. Thus, if at any time the sum of 
the foundation voting level and the disqualified peson voting level is 
less than the immediately preceding substituted combined voting level, 
the substituted level shall be decreased so that it equals such sum. For 
example, if on May 26, 1969, a foundation and all disqualified persons 
together have holdings in a business enterprise equal to 50 percent, on 
such date the substituted combined voting level and the disqualified 
person voting level equal 50 percent (since such holdings of the 
foundation are treated as held by a disqualified person). If the private 
foundation or a disqualified person on May 27, 1969, sold 2 percent of 
such holdings to a nondisqualified person, the disqualified person 
voting level would be decreased to 48 percent (50%-2%), causing the 
substituted combined voting level to be decreased to 48 percent. As a 
further example, assume that on May 26, 1969, a foundation and all 
disqualified persons together have holdings in a business enterprise 
equal to 50 percent, and when the first phase expires on May 26, 1979, 
the substituted combined voting level is still 50 percent, the 
foundation voting level is 10 percent, and the disqualified person 
voting level is 40 percent. If a disqualified person there-

[[Page 130]]

after sells 2 percent to a nondisqualified person so that the sum of the 
disqualified person voting level (40%-2%=38%) and the foundation voting 
level (10%) equals 48 percent (38%+10%), then the substituted combined 
voting level is decreased to 48 percent. Similarly, if at any time the 
sum of the foundation value level and the disqualified person value 
level is less than the immediately preceding substituted combined value 
level, the substituted combined value level shall be decreased so that 
it equals such sum.
    (D) Restrictions on increases in levels. In addition, none of the 
four levels referred to in paragraph (d)(4)(i)(B) of this section may be 
adjusted upward to reflect any increase in the holdings comprising such 
level, except as provided in section 4943(c)(5) and Sec. 53.4943-5. As 
a result, any transfer of May 26, 1969, holdings from a disqualified 
person to a private foundation shall not increase the foundation voting 
level or the foundation value level (unless the transfer qualifies under 
section 4943(c)(5)), and thus may reduce the substituted combined value 
level (and where appropriate, the substituted combined voting level). 
Thus, in the last preceding example, if the disqualified person, instead 
of selling the 2 percent interest to a nondisqualified person, had sold 
such interest to the foundation, the substituted combined voting level 
would still be reduced to 48 percent, since the disqualified person 
voting level would be reduced by 2 percent (to 38%) but the foundation 
voting level would not be increased by 2 percent (remaining at 10%). 
However, any transfer of May 26, 1969, holdings from a private 
foundation to a disqualified person under section 101(1)(2)(B) of the 
Tax Reform Act of 1969, shall reduce the foundation value level (and, 
where appropriate, the foundation voting level), but will not reduce the 
substituted combined value level or the subsituted combined voting 
level. The disqualified person voting level and disqualified person 
value level are correspondingly increased, not being limited to interest 
held since May 26, 1969. In addition, a transfer of May 26, 1969, 
holdings from one disqualified person to another, for example, by 
bequest, shall not reduce the substituted combined voting level nor the 
substituted combined value level.
    (ii) Exceptions--(A) One percent de minimus rule. If after May 26, 
1969, there are one or more decreases in the holdings comprising any of 
the four levels referred to in paragraph (d)(4)(i)(B) of this section 
during any taxable year of a private foundation, and if such decreases 
are attributable to issuances of stock (or such issuances coupled with 
redemptions), then, unless the aggregate of such decreases equals or 
exceeds 1 percent, the determination of whether there is a decrease in 
such level for purposes of this paragraph (d)(4) shall be made only at 
the close of such taxable year. If, however, the aggregate of such 
decreases equals or exceeds 1 percent, such level shall be decreased at 
that time as if the previous sentence has never applied.
    (B) Twenty percent (or 35 percent) floor. In no event shall the 
downward rachet rule contained in paragraph (d)(4)(i) of this section 
decrease the substituted combined voting level or the substituted 
combined value level below 20 percent, or, for purposes of section 
4943(c)(2)(B), below 35 percent.
    (iii) Special rules--(A) Change of foundation managers. In the case 
of a foundation manager (as defined in section 4946(b)) who on May 26, 
1969, owns holdings in a business enterprise and who is replaced by 
another foundation manager, the decrease in the substituted combined 
voting or value levels shall be limited to the excess, if any, of the 
departing foundation manager's holdings over his successor's holdings.
    (B) Termination of private foundation status under section 507. If 
an organization gives the notification described in section 
507(b)(1)(B)(ii) of the commencement of a 60-month termination period 
and fails to meet the requirements of section 509(a)(1), (2) or (3) for 
the entire period, then such organization will be treated as a private 
foundation during the entire 60-month period for purposes of this 
paragraph (d)(4) and section 4946(a)(1)(H). For example, X, a private 
foundation gives notification of the commencement of a 60-month 
termination commencing on

[[Page 131]]

January 1, 1972. X and Y, another private foundation, are effectively 
controlled by the same persons within the meaning of section 
4946(a)(1)(H). X and Y hold 25 percent each of the voting stock of Z 
corporation on May 26, 1969, so that the substituted combined voting 
level for X or Y is 50 percent on such date. If X meets the requirements 
of section 509(a) (1), (2), or (3) for the entire 60-month period, 
section 4946(a)(1)(H) is inapplicable to X, and, under the downward 
ratchet rule, the substituted combined voting level for Y is decreased 
by 25 percent. On the other hand, if X meets the requirements of section 
509(a)(2) for its taxable years 1972 and 1973, but fails to meet the 
requirements of section 509(a) (1), (2), or (3) in 1974, 1975, and 1976, 
then solely for purposes of section 4943(c)(4)(A)(ii) and this paragraph 
(d)(4), X will be treated as a disqualified person with respect to Y, 
and Y will be treated as a disqualified person with respect to X, for 
taxable years 1972 through 1976 pursuant to section 4946(a)(1)(H). Thus, 
for purposes of section 4943(c)(4)(A)(ii) the substituted combined 
voting level for X or Y will not be decreased by reason of the fact that 
X was attempting to terminate under section 507(b)(1)(B), and assuming 
no other transportations, such level; will remain at 50 percent.
    (iv) Examples. The provisions of this paragraph (d)(4) may be 
illustrated by the following examples:

    Example 1. F, a private foundation, owns on May 26, 1969, 50 shares 
of voting stock in corporation X representing to 50 percent of the 
voting stock in X and 25 percent of the value of all outstanding shares 
of all classes of stock in X. A and B, the only disqualified persons 
with respect to F, together own, on such date, 2 shares of voting stock 
in X representing 2 percent of the voting shock in X and 1 percent of 
the value of all outstanding shares of all classes of stock in X. In 
addition, on such date, F owns 30 shares of nonvoting stock in X, 
representing 30 percent of the value of all outstanding shares of all 
classes of stock in X, and A and B together own 15 shares of nonvoting 
stock in X representing 15 percent of the value of all outstanding 
shares of classes of stock in X. The provisions of section 
4943(c)(4)(B)(iii) apply and during the 10-year period beginning on May 
26, 1969, a disqualified person is deemed to hold all interests of F in 
X. Assume that on February 1, 1972, F sells to C, unrelated in 
individual, 12 shares of voting stock in X representing 12 percent of 
the voting stock in X and 6 percent of the value of all outstanding 
shares of all classes of stock in X.
    (i) Beginning on May 26, 1969, the disqualified person voting level 
is 52 percent, the foundation voting level is zero, and the substituted 
combined voting level is 50 percent; the disqualified person value level 
is 71 percent, the foundation value level is zero, and the substituted 
combined value level is 50 percent.
    (ii) Beginning on February 1, 1972, the disqualified person voting 
level is 40 percent (52%-12%), the foundation voting level is zero, and 
the substituted combined voting level is 40 percent; the disqualified 
person value level is 65 percent (71%-6%), the foundation value level is 
zero and the substituted combined value level is 50 percent.
    Example 2. F, a private foundation on the calendar year basis, 
holds, on May 26, 1969, 30 percent of the voting stock in corporation Y. 
C and D, the only disqualified persons with respect to F, together hold, 
on such date, 10 percent of the voting stock in Y. The provisions of 
section 4943(c)(4)(B)(iii) apply with respect to F, and disqualified 
persons are deemed to hold all interests of F in Y for the 10-year 
period beginning on May 26, 1969, so that the substituted combined 
voting level as of such date is 40 percent. On February 1, 1973, a stock 
issuance by Y causes the combined holdings of voting power by F, C, and 
D in Y to decrease by 0.3 percent. on June 1, 1973, another such 
issuance causes such combined holdings to decrease by 0.5 percent. In 
September 1, 1973, an unrelated stock redemption by Y causes such 
combined holdings to increase by 0.4 percent. Under this paragraph the 
determination whether there is a decrease in the substituted combined 
voting level for purposes of the downward ratchet rule shall not be made 
before January 1, 1974, since the aggregate of the decreases occurring 
on February 1 and June 1 of 1973 is less than 1 percent (0.3%+0.5%). 
Therefore, the substituted combined voting level as of January 1, 1974, 
is 39.6 percent (40%-[(0.3%+0.5%)-0.4%].)
    Example 3. Assume the facts as stated in Example (2), except that, 
on October 1, 1973, a stock issuance by Y causes the combined holdings 
of voting power by F, C, and D in Y to decrease by 0.3 percent. Since 
the aggregate of the decreases occurring on February 1, June 1, and 
October 1 of 1973 exceeds 1 percent, the determination whether there is 
a decrease in the substituted combined voting level shall be made as of 
October 1, 1973. At that time the substituted combined voting level 
shall be reduced to 39.2 percent (40%-0.3%-0.5%), the lowest actual 
combined holdings during the period that the de minimis rule was in 
effect.

    (5) Permitted holdings--Second phase--(i) In general. For purposes 
of section

[[Page 132]]

4943 and this section, the term ``second phase'' means the 15-year 
period immediately following the first phase. Upon the expiration of the 
first phase with respect to an interest to which section 4943(c)(4) 
applies, such interest shall no longer be treated as held by a 
disqualified person under section 4943(c)(4)(B). During the second 
phase, the manner of determining the permitted holdings of a private 
foundation to which section 4943(c)(4) applies shall be the same as 
applicable to the first phase, except that a 25 percent maximum shall 
apply under certain conditions specified in paragraph (d)(5)(ii) of this 
section. For these purposes the substituted combined voting level and 
the substituted combined value level in effect for the foundation at the 
end of the first phase shall be carried over to the second phase. The 
substituted levels are carried over because although there is a decrease 
in the disqualified person levels (since holdings are no longer treated 
as held by disqualified persons under section 4943(c)(4)(B)), a 
corresponding increase in the foundation levels occurs. For example, if 
a private foundation on May 26, 1969, held 10 percent of the voting 
stock in a corporation and disqualified persons held 40 percent of the 
voting stock, both the disqualified person voting level and the 
substituted combined voting level equal 50 percent (10%+40%). Assuming 
no transactions during the first phase, on May 26, 1979, the 
disqualified person voting level would be decreased to 40 percent (50%-
10%), but the foundation voting level would be increased to 10 percent 
so that the substituted combined voting level would remain at 50 
percent. In addition, the downward ratchet rule of paragraph (d)(4) of 
this section shall continue to apply, to prevent the foundation and 
disqualified persons from purchasing any additional interest in the same 
enterprise until the substituted combined voting level decreases below 
20 percent.
    (ii) 25 percent maximum on foundation holdings. If, or as soon as, 
the disqualified person voting level exceeds 2 percent after the 
expiration of the first phase, the permitted holdings shall not 
thereafter exceed 25 percent of the voting stock or 25 percent of the 
value of all outstanding shares of all classes of stock, even though the 
holdings of the foundation and all disqualified persons combined do not 
exceed the substituted level. Solely for purposes of determining whether 
the 25 percent limitation of this subdivision (ii) applies, the 
disqualified person voting level shall not be treated as exceeding 2 
percent solely as a result of the holdings of a private foundation which 
are treated as held by a disqualified person by reason of section 
4943(c) (5) or (6). For example, where under the constructive ownership 
rules for trusts in Sec. 53.4943-8(b), a private foundation is deemed 
to own more than 2 percent of the voting stock of a business enterprise 
but such stock is treated as held by a disqualified person under section 
4943(c)(5), the determination of the substituted percentage for 
permitted holdings in the second phase will be as if the foundation 
owned the stock held by the trust. Similarly, where a private foundation 
is the only remainder beneficiary of a trust that is a disqualified 
person under section 4946(a)(1)(H), the disqualified person voting level 
shall not be treated as exceeding 2 percent solely as a result of the 
holdings of such a trust.
    (6) Permitted holdings--Third phase. For purposes of section 4943 
and this section, the term ``third phase'' means the entire period 
following the second phase. During the third phase the manner of 
determining the permitted holdings of a private foundation to which 
section 4943(c)(4) applies shall be the same as applicable to the second 
phase under paragraph (d)(5) of this section (including the carryover of 
levels from the earlier phase). However, if the 25 percent limit of 
paragraph (d)(5)(ii) of this section never applied during the second 
phase, the substituted combined voting level and the substituted 
combined value level each shall not exceed 35 percent during the third 
phase.
    (7) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. F, a private foundation, owns on May 26, 1969, 30 shares 
of voting stock in corporation Z representing 30 percent of the voting 
power in Z and 15 percent of the value of all outstanding shares of all 
classes of stock in Z, and owns, on such date, 10 shares of nonvoting 
stock in Z representing 10 percent of the value of all outstanding 
shares of

[[Page 133]]

all classes of stock in Z. E and G, the only disqualified persons with 
respect to F, own, on such date, 5 shares each of nonvoting stock in Z. 
The 10 shares of nonvoting stock in Z owned by E and G together 
represent 10 percent of the value of all outstanding shares of all 
classes of stock in Z. Assume further that F cannot meet the 
requirements for the 35 percent test of section 4943(c)(2)(B). For 
purposes of applying section 4943(c)(4)(B) and this paragraph, F has 
excess business holdings in Z (determined without regard to section 
4943(c)(4)), because under section 4943(c)(2)(A) F's permitted holdings 
are 20 percent (20%-0%) of the voting stock since disqualified persons 
have no holdings of voting stock. Therefore, section 4943(c)(4)(B) and 
this paragraph apply, and a disqualified person is treated as holding 
F's shares of both voting and nonvoting stock in Z for the 10-year 
period through May 25, 1979. Thus, since all holdings by F in Z are 
treated as held by a disqualified person during the first phase, F 
cannot be subject to tax under section 4943(a) on its May 26, 1969, 
holdings prior to the termination of the first phase, regardless of 
whether or not disqualified persons purchase additional shares of Z 
during the first phase.
    Example 2. Assume the same facts as in Example (1), and further 
assume that there were no transactions in the stock of Z during the 
first phase (May 26, 1969 through May 25, 1979). During the first phase 
the permitted holdings by F in Z for both the voting stock and the value 
is zero. The disqualified person voting level and the substituted 
combined voting level are each 30 percent, and the disqualified person 
value level and the substituted combined value level are each 35 percent 
(15%+10%+10%). The substituted levels are carried over into the second 
phase. The disqualified person voting level on May 26, 1979, the 
beginning of the second phase, is zero, because the voting shares held 
by F are no longer treated as held by a disqualified person. Therefore, 
F's permitted holdings on such date are 30 percent of the voting stock, 
because such percentage is equal to the excess of the substituted 
combined voting level (30%) over the disqualified person voting level 
(0%). The disqualified person value level on May 26, 1979, is 10 
percent, because the voting and nonvoting shares held by F are no longer 
treated as held by a disqualified person. Therefore, F's permitted 
holdings on such date are 25 percent of the value of Z stock, because 
such percentage is equal to the excess of the substituted combined value 
level (35%) over the disqualified person value level (10%) as of such 
date.
    Example 3. Assume the facts as stated in Example (2), except that E 
and G acquire, on February 1, 1970, 10 shares of Z voting stock 
representing 10 percent of the voting power in Z and 5 percent of the 
value of all outstanding shares of all classes of stock in Z. During the 
first phase such permitted holdings remain zero, and prior to May 25, 
1979, the substituted combined voting level and substituted combined 
value level remain 30 and 35 percent, respectively, because such levels 
may not be increased by acquisitions by disqualified persons. However, 
the disqualified person voting level and the disqualified person value 
level are each increased to 40 percent (30%+10%) and 40 percent (35%+5%) 
respectively. During the first phase the excess of the disqualified 
person voting level over the substituted combined voting level (40%-30%) 
and the excess of the disqualified person value level over the 
substituted combined value level (40%-35%) indicate how much stock F 
must dispose of during the first phase to avoid the initial tax when it 
expires. On May 25, 1979, the last day of the first phase, F disposes of 
12 shares of Z voting stock, representing 12 percent of the voting power 
in Z and 6 percent of the value of all such outstanding shares. The 
disposition by F reduces the interest F owns to 18 percent (30%-12%) of 
the voting power, and 19 percent (25%-6%) of the value of all 
outstanding shares of all classes of stock, in Z. Since the disqualified 
person voting level decreases to 28 percent (40%-12%), the substituted 
combined voting level as of May 25, 1979, accordingly is decreased to 28 
percent under the downward ratchet rule. Similarly, the substituted 
combined value level is decreased to 34 percent, as the disqualified 
person value level as of such date is 34 percent (40%-6%). On May 26, 
1979, the disqualified person voting level is 10 percent (28%-18%), and 
the disqualified person value level is 15 percent (34%-19%), since the 
shares owned by F are no longer treated as held by a disqualified person 
as of such date. Accordingly, on May 26, 1979, the permitted holdings by 
F and Z are 18 percent of the voting power in Z, because such percentage 
is equal to the excess of the substituted combined voting level (28%) 
over the disqualified person voting level (10%) as of such date. 
Similarly, the permitted holdings of F in Z by value are 19 percent 
(34%-15%). If F had not disposed of the 12 shares, then on May 26, 1979, 
F's permitted holdings in voting power and value would be 20 percent 
(30%-10%) and 20 percent (35%-15%), respectively.
    Example 4. F, a private foundation, owns on May 26, 1969, 35 shares 
of voting stock in corporation Y representing 35 percent of the voting 
stock in Y and 17.5 percent of the value of all classes of stock in Y, 
and owns on such date 45 shares of nonvoting stock representing 22.5 
percent of the value of all outstanding shares of all classes of stock 
in Y. No disqualified person with respect to F owns, on such date, any 
stock in Y. Assume further that Y cannot meet the requirements of the 35 
percent test of section 4943(c)(2)(B). For purposes of applying section 
4943(c)(4)(B) and this paragraph, F has excess business

[[Page 134]]

holdings in Y (determined without regard to section 4943(c)(4)), because 
under section 4943(c)(2)(A) F's permitted holdings are 20 percent (20%-
0%) of the voting stock since disqualified persons have no holdings of 
voting stock. Therefore, section 4943(c)(4)(B) and this paragraph apply, 
and a disqualified person is treated as holding F's shares of both 
voting and nonvoting stock in Y for the 10-year period through May 25, 
1979. During the first phase the permitted holdings by F in Y of both 
the voting stock and of value are zero. The disqualified person voting 
level and the substituted combined voting level are each 35 percent, and 
the disqualified person value level and the substituted combined value 
level are each 40 percent (17.5%+22.5%). The substituted levels are 
carried over into the second phase. The disqualified person voting level 
and value level on May 26, 1979, are both zero, because the shares held 
by F are no longer treated as held by a disqualified person. Therefore, 
F's permitted holdings on such date are 35 percent of the voting power 
(35%-0%) and 40 percent of the value (40%-0%). Assume that on February 
1, 1981, A, a disqualified person, acquires 6 percent of the voting 
stock in Y representing 3 percent of the value of all outstanding shares 
of all classes of stock in Y. The permitted holdings by F in Z on 
February 1, 1981, are thus reduced to 25 percent of the voting stock 
(the lesser of the separate 25% second phase limitation or 29% (35% 
substituted combined voting level minus 6% disqualified person voting 
level)) and 25 percent of the value (the lesser of the separate 25% 
second phase limitation or 37% (40% substituted combined value level 
minus 3% disqualified person value level)). But see paragraph (d)(8) of 
this section for limitations on restrictions with respect to nonvoting 
stock.
    Example 5. Assume the same facts as in Example (4) except that A 
does not acquire the 6 shares of voting stock until February 1, 1996 (in 
the third phase), rather than on February 1, 1981. Thus, F's permitted 
holdings in Y would remain at 35 percent of the voting stock and 40 
percent of the value during the second phase, which expired on May 25, 
1994. Assume that on May 25, 1994, the last day of the second phase, F 
disposes of 10 shares of nonvoting stock representing 5 percent of the 
value of all outstanding shares in Y to meet the 35 percent third phase 
limit. In accordance with the downward ratchet rule, the substituted 
combined value level and F's permitted holdings in Y would be reduced to 
35 percent of value. On February 1, 1996, F's permitted holdings in Y 
would be reduced to 25 percent of the voting stock (the lesser of the 
separate 25% third phase limitation or 29% (35% substituted combined 
voting level minus 6% disqualified person level)) and 25 percent of the 
value (the lesser of the separate 25% third phase limitation or 32% (35% 
substituted combined value level minus 3% disqualified person value 
level)). But see paragraph (d)(8) of this section for limitations on 
restrictions with respect to nonvoting stock.

    (8) Special rule where all holdings are permitted under section 
4943(c)(2). (i) Since section 4943(c)(4) and this paragraph provide 
transitional rules for foundations which would otherwise have had excess 
business holdings on May 26, 1969, no holdings shall cease to be 
permitted holdings under this paragraph where such holdings would be 
permitted holdings under section 4943(c)(2) and Sec. 53.4943-3. Thus, 
for example, where the substituted combined voting level had been 
reduced to 20 percent, the provisions of Sec. 53.4943-3(b)(2) 
concerning nonvoting stock as permitted holdings generally apply.
    (ii) The provisions of this paragraph (d)(8) may be illustrated by 
the following example:

    Example. (A) F, a private foundation, owns, on May 26, 1969, 40 
shares of voting stock in corporation X representing 40 percent of the 
voting stock in X and 20 percent of the value of all outstanding shares 
of all classes of stock in X, and owns, on such date, 60 shares of 
nonvoting stock in X, representing 30 percent of the value of all 
outstanding shares of all classes of stock in X. A, the only 
disqualified person with respect to F, owns, on such date, 10 shares of 
voting stock in X, representing 10 percent of the voting stock in X and 
5 percent of the value of all outstanding shares of all classes of stock 
in X. Under section 4943(c)(4)(B)(iii), a disqualified person is deemed 
the owner of all holdings by F in X for the 10-year period beginning on 
May 26, 1969.
    (B) Assume that the only transaction in X stock during the first 
phase is the disposition of 30 shares of voting stock by F on May 1, 
1975. The voting stock held by F is permitted holdings under Sec. 
53.4943-3 and under such section since all disqualified persons together 
do not own more than 20 percent of the voting stock in X, all nonvoting 
stock held by F shall also be treated as permitted holdings. Therefore, 
all the stock held by F is permitted holdings.
    (C) Assume that on May 1, 1975, F had disposed of only 15 shares of 
voting stock and also had disposed of 35 shares of nonvoting stock. On 
May 26, 1979, at the beginning of the second phase, this paragraph 
(d)(8) would not apply since F would have excess business holdings under 
Sec. 53.4943-3. Under the provisions of this section, the permitted 
holdings by F in X on such date are 25 percent of the

[[Page 135]]

voting stock (35% substituted combined voting level minus 10% 
disqualified person voting level) and 25 percent of the value (30% 
substituted combined value level minus 5% disqualified person value 
level).

    (9) Special rule for certain private foundations. In the case of a 
private foundation:
    (i) Which was incorporated before January 1, 1951.
    (ii) Substantially all of the assets of which on May 26, 1969, 
consisted of more than 90 percent of the stock of an incorporated 
business enterprise which is licensed and regulated, the sales or 
contracts of which are regulated, and the professional representatives 
of which are licensed, by State regulatory agencies in at least 10 
States;
    (iii) Which acquired such stock solely by gift, devise, or bequest;
    (iv) Which does not purchase any stock or other interest in such 
enterprise after May 26, 1969, and does not acquire any stock or other 
interest in any other business enterprise which constitutes excess 
business holdings under Sec. 53.4943-3; and
    (v) Which, in the last 5 taxable years ending on or before December 
31, 1970, expended substantially all of its adjusted net income (as 
defined in section 4942(f)) for the purpose or function for which it is 
organized and operated;

paragraph (d) (1) through (5) of this section (permitted holdings during 
the first and second phase) shall be applied with respect to the 
holdings of such foundation in such incorporated business enterprise by 
substituting ``51 percent'' for ``50 percent,'' and section 
4943(c)(4)(D) (third phase) shall not apply with respect to such 
holdings. For purposes of the preceding sentence, stock of such 
enterprise in a trust created before May 27, 1969, of which the 
foundation is the remainder beneficiary shall be deemed to be held by 
such foundation on May 26, 1969, if such foundation held (without regard 
to such trust) more than 20 percent of the stock of such enterprise on 
May 26, 1969.
    (10) Special rule for changes in the relative values of stock of 
different classes. (i) In the case of a corporation that has more than 
one class of stock outstanding, if the percentage of value held by the 
private foundation, its disqualified persons, or both, increases over a 
period of time solely as a result of changes in the relative values of 
the stock of different classes, then the foundation value level, the 
disqualified person value level, and the substituted combined value 
level, as defined in paragraph (d)(2) of this section, shall be adjusted 
to reflect such increase. An increase in the percentage of value held 
shall not be considered to have occurred solely as a result of changes 
in the relative values of the stock of different classes if:
    (A) There has been any increase during the period in the percentage 
of any class of stock held by the private foundation, its disqualified 
persons, or both, or
    (B) There has been any issuance, redemption, or purchase by the 
issuing corporation of any stock during the period.

See Sec. 53.4943-6(d) for rules relating to increases caused by 
readjustments.
    (ii) Example. The provisions of this paragraph (b)(10) may be 
illustrated by the following example:

    Example. (i) At all times since May 26, 1969, F, a private 
foundation, has held 25% (500,000 shares) of the outstanding class of 
voting stock of X corporation. No disqualified person with respect to F 
holds any voting stock of X. In addition X has had outstanding since May 
26, 1969, a class of non-voting preferred stock, none of which is held 
by F or a disqualified person. X is an active business corporation and 
third parties do not have effective control of X. On May 26, 1969, the 
voting stock (2 million shares outstanding) was trading for $5 a share 
on the New York Stock Exchange. The non-voting preferred stock, not 
publicly traded, was valued at $1 million. The total value of all 
outstanding stock was $11 million ($10 million voting stock plus $1 
million non-voting preferred). On May 26, 1969, F held 22.73% of the 
value of X's outstanding stock ($2.5 million/$11 million).
    (ii) On October 31, 1982, X's voting stock is trading for $20 a 
share and the nonvoting stock is valued at $3 million. At all times 
during the period May 26, 1969, through October 31, 1982, F has held 25 
percent of the voting stock and none of the nonvoting stock of X. No 
stock of X is owned by disqualified persons. No stock of X has been 
issued, redeemed or purchased by X during this period. On October 13, 
1982, the total value of X's outstanding stock (is $43 million ($40 
million voting stock and $3 million nonvoting stock) and F holds 23.26 
percent of the value of X's outstanding stock ($10 million/$43 million).

[[Page 136]]

F's foundation value level and the substituted combined value level are 
increased from 22.73 percent to 23.26 percent to reflect this change.
    (iii) On November 1, 1982, X corporation distributes the stock of Y 
corporation, a wholly-owned subsidiary, to X's shareholders. Y is a 
business enterprise. Under this paragraph (d)(10), all of F's stock in X 
is permitted holdings under section 4943 (c)(4) even though the 
percentage of value held by F has increased from 22.73 percent on May 
26, 1969, to 23.26 percent on November 1, 1982. F's permitted holdings 
in Y will be determined by reference to F's permitted holdings in X 
under Sec. 53.4943-7. Therefore, assuming no prohibited transaction 
occurs, F's permitted holdings in Y stock equal 25 percent of Y's voting 
stock and, separately, 23.26 percent of the value of all of Y's 
outstanding stock.

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR 
6478, Feb. 22, 1984]



Sec. 53.4943-5  Present holdings acquired by trust or a will.

    (a) Interests to which section 4943(c)(5) applies--(1) In general. 
Section 4943(c)(5) provides that section 4943(c)(4) (other than the 20-
year first phase holding period) applies to an interest in a business 
enterprise acquired after May 26, 1969 by a private foundation under the 
terms of a trust which was irrevocable on May 26, 1969, or under the 
terms of a will executed on or before May 26, 1969, which were in effect 
on May 26, 1969, and at all times thereafter, as if such interest were 
held on May 26, 1969. However the first phase holding period prescribed 
by Sec. 53.4943-4(c)(1) (ii) or (iii) shall commence for such an 
interest on the date of distribution to the foundation. Unlike section 
4943(c)(4) and Sec. 53.4943-4, section 4943(c)(5) and this section 
treat only the interest so acquired (and not the entire interest held by 
the foundation in such enterprise on the date of distribution) as held 
by a disqualified person during a first phase holding period. (See, 
however, section 4943(c)(6) and paragraph (b)(2) of Sec. 53.4943-6 for 
the treatment of other holdings of the foundation in the same enterprise 
if an interest to which section 4943(c)(5) applies is acquired from a 
person who was not a disqualified person prior to the acquisition.) In 
addition, section 4943(c)(5) and this section shall not apply if after 
the acquisition of such an interest the foundation would not have excess 
business holdings (determined without regard to section 4943(c) (4), 
(5), or (6)).
    (2) After-acquired interests. Section 4943(c)(5) and this section 
shall not apply to any interest acquired after May 26, 1969, by an 
estate or trust, other than by reason of the death of the decedent. For 
example, where a foundation is a residuary beneficiary under the terms 
of a will executed before May 26, 1969, and the residue of the estate 
consists of cash, then stock subsequently purchased with cash for 
distribution to the foundation will not be treated as an interest 
acquired under the terms of a will executed on or before May 26, 1969.
    (3) Certain revocable trusts. If an interest in a business 
enterprise actually passes to a private foundation under a trust which 
would have met the tests referred to in paragraph (a)(1) of this section 
but for the fact that the trust was revocable (even though it was not in 
fact revoked) and such interest would have passed to such foundation 
under a will that meets those tests but for the fact that the grantor 
died without having revoked the trust, then for purposes of section 
4943(c)(5) and this section, such an interest shall be treated as having 
been acquired by the foundation under the will.
    (4) Modification of will--(i) In general. For purposes of section 
4943(c)(5) and this section, an amendment or republication of a will 
which was executed on or before May 26, 1969, does not prevent any 
interest in a business enterprise which was to pass under the terms 
(which were in effect on May 26, 1969, and at all times there- after) of 
such will from being treated as a present holding under section 4943(c) 
(4) or (5):
    (A) Solely because there is a reduction in the interest in the 
business enterprise which the foundation was to receive under the terms 
of the will (for example, if the foundation is to receive the residuary 
estate, and if one class of stock is disposed of by the decedent during 
his lifetime or by a subsequent codicil);
    (B) Solely because such amendment or republication is necessary in 
order to comply with section 508(e) and the regulations thereunder;

[[Page 137]]

    (C) Solely because there is a change in the executor of the will; or
    (D) Solely because of any other change which does not otherwise 
change the rights of the foundation with respect to such interest in the 
business enterprise.

However, if under such amendment or republication there is an increase 
in the interest in the business enterprise which the foundation was to 
receive under the terms of the will in effect on May 26, 1969, such 
increase shall not be treated as present holdings under section 4943(c) 
(4) or (5). Under such circumstances the interest which would have been 
acquired before such increase shall remain present holdings. See section 
4943(c)(6) and Sec. 53.4943-6 with respect to the treatment of such 
increase in holdings of a private foundation.
    (ii) Examples. The provisions of this paragraph (a)(4) may be 
illustrated by the following examples:

    Example 1. On May 9, 1985, A modifies by codicil his will which was 
in effect on May 26, 1969, and was unchanged until such modification. 
The purpose of the codicil was, in the event of A's death, to increase 
the number of shares in X Corporation that would pass to the W 
foundation from 70 percent of all the voting power and value to 80 
percent. Under these facts, if A dies without further modifying the 
terms of the will which apply to W's interest in X, section 4943(c)(5) 
will apply to 70 percent of the X voting power and value and section 
4943(c)(6) will apply to 10 percent of the X voting power and value, 
since 10 percent of the X voting power and value would not pass under a 
provision of the will which was in effect on May 26, 1969, and at all 
times thereafter. Accordingly, if the stock is distributed to W on July 
6, 1988, then, assuming that on May 26, 1969, W and all disqualified 
persons owned less than 75% of the voting stock in X, an amount of such 
stock representing 70 percent of X voting power and value shall be 
treated as held by a disqualified person through July 5, 1998, and an 
amount of such stock representing 10 percent of X voting power and value 
shall be treated as held by a disqualified person through July 5, 1993.
    Example 2. Assume the facts as stated in Example (1), except that 
the sole purpose of the codicil was to change the executor of the will. 
Under paragraph (a)(4)(i) of this section, such codicil will not prevent 
the X voting stock which was bequeathed to W from being treated as held 
by a disqualified person through July 5, 1998.

    (b) Holding periods--(1) In general. An interest to which section 
4943(c)(5) applies shall be entitled to a 15-year holding period 
starting on the date of distribution only if the interests actually or 
constructively owned by a private foundation and all disqualified 
persons on May 26, 1969, in a business enterprise exceed 75 percent of 
the voting stock (or of the profits or beneficial interest) or 75 
percent of the value of all outstanding shares of all classes of stock 
(or of the profits and capital interest) in such enterprise. For 
purposes of the preceding sentence, interests held by the foundation on 
May 26, 1969, shall be deemed to include an interest to which section 
4943(c)(5) applies and which has been acquired (on or before the date of 
distribution for the interest in question) from a person who was not a 
disqualified person on May 26, 1969. Therefore, if under the terms of a 
will in effect on May 26, 1969, and at all times thereafter, a private 
foundation is created on July 1, 1975, and receives 76 percent of the 
voting stock of a business enterprise on that date, such stock shall be 
treated as held by a disqualified person until June 30, 1990. Any 
interest to which section 4943(c)(5) applies but which is not entitled 
to a 15-year holding period shall be entitled to a 10-year holding 
period starting on the date of distribution. For purposes of this 
paragraph the date of distribution shall be deemed to occur no later 
than the date on which the trust or estate is considered to be 
terminated under Sec. 1.641(b)-(3) of this chapter (Income Tax 
Regulations).
    (2) Constructive ownership prior to date of distribution. To the 
extent that an interest to which section 4943(c)(5) applies is 
constructively held by a private foundation under section 4943(d)(1) and 
Sec. 53.4943-8 prior to the date of distribution, it shall be treated 
as held by a disqualified person prior to such date by reason of section 
4943(c)(5). In addition, in the case of a foundation's interest in a 
trust which was irrevocable on May 26, 1969, and to which both sections 
4943 (c)(4) and (c)(5) apply, the first phase holding period for such 
interest shall end with whichever such period under section 4943(c) (4) 
or (5) ends later. For example, if under the terms of such a trust, 96 
percent of the

[[Page 138]]

voting stock in a business enterprise was constructively held by a 
private foundation on May 26, 1969, and was distributed to such 
foundation on June 30, 1970, such interest is entitled to a 20-year 
holding period beginning on May 26, 1969.
    (c) Permitted holdings--(1) In general. The permitted holdings of a 
private foundation which has an interest in a business enterprise to 
which section 4943(c)(5) applies shall be determined in accordance with 
the rules of paragraph (d) of Sec. 53.4943-4. The levels referred to in 
such paragraph shall be adjusted to take into account the acquisition of 
such an interest as if it were treated as held by a disqualified person 
from May 26, 1969, until the date of acquisition. See also Sec. 
53.4943-6(b)(2) for the special rule for interests held by a private 
foundation at the time it acquires a section 4943(c)(5) interest from a 
nondisqualified person. Thus, for example, if on June 30, 1975, the 
disqualified person voting level and the substituted combined voting 
level in corporation X with respect to foundation F are 45 percent, and 
a nondisqualified person's 10 percent voting interest in X is acquired 
by F on July 1, 1975, in a transaction to which section 4943(c)(5) 
applies, the above-mentioned levels shall be increased to 55 and 50 
percent respectively, on July 1, 1975. However, if such interest had 
been acquired from a person who was a disqualified person on May 26, 
1969, rather than from a nondisqualified person, no adjustments in such 
levels would have taken place on July 1, 1975. In such a case, though, 
at the beginning of the second phase on July 1, 1985, the foundation 
voting level would be increased by 10 percent, and the disqualified 
person voting level decreased by 10 percent (assuming that none of the 
acquired stock had been disposed of prior to such date).
    (2) Separate phases. The phases for each interest to which section 
4943(c)(5) applies start independently from those for any other interest 
of the foundation in the same enterprise to which section 4943(c) (4) or 
(5) applies. Therefore, until an interest enters its own second phase, 
the 25 percent limit described in paragraph (d)(5) of Sec. 53.4943-4 
shall not apply to such interest since such interest (and any 
subsequently acquired section 4943(c)(5) interest in the first phase) is 
still treated as held by a disqualified person for purposes of that 25 
percent limit. In addition, if such an interest enters its second phase 
and at such time all disqualified persons together do not have holdings 
in excess of 2 percent of the voting stock in the same business 
enterprise, then the 25 percent limit of section 4943(c)(4)(D)(i) shall 
not then apply to such interest, even though such limit may have been 
applicable to an interest with an earlier second phase. Moreover, the 35 
percent limit of section 4943(c)(4)(D)(ii) shall cause only interests 
which have entered the third phase to become excess business holdings, 
taking into account, however, interests in prior phases in determining 
the holdings subject to such limit.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples: (After each example is a chart setting forth the 
chronological changes in the various levels referred to in paragraph (d) 
of Sec. 53.4943-4.)

    Example 1. On May 26, 1969, F, a private foundation, owns no stock 
in M Corporation, and A, a disqualified person owns 40 percent of the 
voting stock (voting power and value) in M. A dies on May 1, 1971, 
leaving 30 percent of the voting stock in M to F and leaving the other 
10 percent to a disqualified person. Distribution is made on June 1, 
1972, and assume that section 4943(c)(5) applies. No transactions in the 
stock of M, other than those described in this example, occur. On May 
26, 1969, the substituted combined voting level is 40 percent, the 
disqualified person voting level is deemed to be 40 percent, and the 
permitted holdings by F in M is deemed to be 0 percent (40%-40%). On May 
1, 1971 (the date that F acquired the M stock by reason of its 
constructive ownership of A's estate), the various levels remain 
unchanged. On May 1, 1971, the 30 percent interest is treated as held by 
a disqualified person for a period extending through May 31, 1982. On 
June 1, 1981, F disposes of 6 percent of the voting stock to a 
nondisqualified person. The substituted combined voting level and the 
disqualified person voting level thereby are reduced to 34 percent (40%-
6%) each. On June 1, 1982, at the beginning of the second phase, the 
foundation voting level increases to 24 percent (30%-6%) and the 
disqualified person voting level is reduced to 10 percent (34%-10%). The 
substituted combined voting level as of June 1, 1982, remains at 34 
percent. The permitted holdings as of such date are 24 percent (34%-
10%). If F had not disposed of any holdings prior to June 1, 1982,

[[Page 139]]

F's permitted holdings would have been 25 percent, the lesser of 25 
percent (the limitation of section 4943(c)(4)(D)(i)), or 30 percent 
(40%-10%). Since on such date the 30 percent interest would no longer 
have been treated as held by a disqualified person, F would have had 
excess business holdings of 5 percent (30%-25%).

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                    Interest
                                                   treated as                 Foundation  Substituted  Disqualified
                                         F owns      held by    Disqualified    voting      combined      person     Permitted
                 Date                  (percent)  disqualified   persons own     level       voting    voting level   holdings          Comments
                                                     person       (percent)    (percent)     level       (percent)   (percent)
                                                    (percent)                              (percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969.........................          0            0            40            0          40            40           0
May 1, 1971..........................        +30          +30           -30   ..........  ...........  ............  .........  A dies.
 Do..................................         30           30            10            0          40            40           0
June 1, 1972.........................         30           30            10            0          40            40           0  Distribution.
June 1, 1981.........................         -6           -6   ............  ..........          -6            -6   .........  F sells 6 pct.
 Do..................................         24           24            10            0          34            34           0
June 1, 1982.........................  .........          -24   ............         +24  ...........          -24         +24  2d phase begins.
 Do..................................         24            0            10           24          34            10          24
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 2. (i) On May 26, 1969, F, a private foundation, owns 30 
percent of the voting stock of N Corporation (voting power and value) 
and disqualified persons own 20 percent of the voting stock of N 
Corporation. On May 1, 1971, B, a disqualified person, dies leaving 15 
percent of the voting stock to F. Assume the distribution was made on 
June 1, 1972, and that section 4943(c)(5) applies. On May 26, 1969, the 
substituted combined voting level and the disqualified person voting 
levels are each 50 percent and the permitted holdings are 0 percent 
(50%-50%). On May 1, 1971, and June 1, 1972, these levels remain 
unchanged. On May 1, 1971, the 15 percent interest is treated as held by 
a disqualified person for a period extending through May 31, 1982.
    (ii) On July 1, 1978, F sells 6 percent of the F stock to a 
nondisqualified person, thereby reducing the disqualified person voting 
level and the substituted combined voting level to 44 percent (50%-6%). 
On May 26, 1979, at the beginning of the second phase for F's 1969 
holdings, the foundation voting level is 24 percent (30%-6%), the 
substituted combined voting level is still 44 percent, and the 
disqualified person voting level is 20 percent (44%-24%). The permitted 
holdings are 24 percent (44%-20%). In addition F's 24 percent holdings 
do not exceed the 25 percent limitation of section 4943(c)(4)(D)(i) and 
paragraph (d)(5)(ii) of Sec. 53.4943-4.
    (iii) On August 1, 1981, F sells 16 percent of the N stock to a 
nondisqualified person, thereby reducing the foundation voting level to 
8 percent (24%-16%), and reducing the substituted combined voting level 
to 28 percent (44%-16%). The disqualified person voting level remains at 
20 percent. On June 1, 1982, at the beginning of the second phase for 
F's holdings acquired by will, the substituted combined voting level is 
still 28 percent, the foundation voting level is 23 percent (8%+15%), 
the disqualified person voting level is 5 percent (20%-15%), and the 
permitted holdings are 23 percent (28%-5%).
    (iv) If F had not disposed of the 6 percent on July 1, 1978, then on 
May 26, 1979, at the beginning of the second phase for F's 1969 
holdings, F's permitted holdings would have been 25 percent, the lesser 
of 25 percent (the limitation of section 4943(c)(4)(D)(i), or 30 percent 
(50%-20%). Since F's 30 percent interest would no longer have been 
treated as held by a disqualified person on May 26, 1979, F would have 
had excess business holdings of 5 percent (30%-25%). Similarly, if F had 
not disposed of the 16 percent interest on August 1, 1981 (but had 
disposed of the 6 percent interest), on July 1, 1982, at the beginning 
of the second phase for F's holdings acquired by will, F's permitted 
holdings would have been 25 percent, the lesser of 25 percent (under 
section 4943(c)(4)(D)(i)), or 39 percent (44%-5%). Since as of such date 
F's entire holdings of 39 percent would no longer have been treated as 
held by a disqualified person, F would have had excess business holdings 
of 14 percent (39%-25%).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                  F owns    interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1971    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)   (percent)
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................        30         30   .........          30            20            0          50            50           0

[[Page 140]]

 
May 1, 1971...................................       +15   .........       +15          +15           -15    ..........  ...........  ............  .........  B dies.
 Do...........................................        45         30         15           45             5            0          50            50           0
June 1, 1972..................................        45         30         15           45             5            0          50            50           0   Distribution.
July 1, 1978..................................        -6         -6   .........          -6    ............  ..........         -6            -6    .........  F sells 6 pct.
 Do...........................................        39         24         15           39             5            0          44            44           0
May 16, 1979..................................  .........  .........  .........         -24    ............        +24   ...........         -24         +24   2d phase for 24 pct.
 Do...........................................        39         24         15           15             5           24          44            20          24
Aug. 1, 1981..................................       -16        -16   .........  ............  ............        -16         -16    ............       -16   F sells 16 pct.
 D0...........................................        23          8         15           15             5            8          28            20           8
July 1, 1982..................................  .........  .........  .........         -15    ............        +15   ...........         -15         +15   All in 2d phase.
 Do...........................................        23          8         15            0             5           23          28             5          23
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

    Example. (3). (i) On May 26, 1969, F, a private foundation owns 5 
percent of the voting stock of O Corporation (voting power and value), 
and disqualified persons own 45 percent of the voting stock. C, a 
disqualified person, dies on May 1, 1971, and leaves 41 percent of the 
voting stock of O to F. Assume that distribution is made on June 1, 
1972, and that section 4943(c)(5) applies. On May 26, 1969, the 
substituted combined voting level and the disqualified person voting 
level are 50 percent and the permitted holdings are 0 percent (50%-50%). 
On May 1, 1971, and June 1, 1972, the various levels remain unchanged. 
On May 1, 1971, the 41 percent interest is treated as held by a 
disqualified person for a period extending through May 31, 1982. On May 
26, 1979, at the beginning of the second phase for F's 1969 holdings of 
5 percent, the 5 percent is no longer treated as held by a disqualified 
person, the foundation voting level is 5 percent, the disqualified 
person voting level is reduced to 45 percent (50%-5%), and the 
substituted combined voting level remains at 50 percent. On such date 
F's permitted holdings are 5 percent (50%-45%). Since the 41 percent 
interest is treated as held by a disqualified person, the interest 
treated as held by F (5%) does not exceed the 25 percent limitation of 
section 4943(c)(4)(D)(i).
    (ii) On August 1, 1981, F sells 22 percent of the O stock to a 
nondisqualified person, thereby reducing the foundation voting level to 
0 percent. Since the reductions are first applied to the 1969 holdings 
of 5 percent, 17 percent (22%-5%) applies to the 41 percent interest, 
reducing such interest to 24 percent (41%-17%), and reducing the 
disqualified person voting level to 28 percent (45%-17%). The 
substituted combined voting level is reduced to 28 percent (0%+28%). On 
June 1, 1982, at the beginning of the second phase for F's holdings 
acquired by will, the substituted combined voting level remains at 28 
percent, the foundation voting level is 24 percent, the disqualified 
person voting level is reduced to 4 percent (28%-4%).
    (iii) If F had not disposed of the 22 percent interest prior to June 
1, 1982, F's permitted holdings would have been 25 percent, the lesser 
of 25 percent, (under section 4943(c)(4)(D)(i)), or 46 percent (50%-4%). 
Since as of such date, F's entire holdings of 46 percent would no longer 
have been treated as held by a disqualified person, F would have had 
excess business holdings of 21 percent (46%-25%).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                  F owns    interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1971    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)   (percent)
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................         5          5   .........           5            45            0          50            50           0   .................................
May 1, 1971...................................       +41   .........       +41          +41           -41    ..........  ...........  ............  .........  C dies.
 Do...........................................        46          5         41           46             4            0          50            50           0
June 1, 1972..................................        46          5         41           46             4            0          50            50           0   Distribution.

[[Page 141]]

 
May 26, 1979..................................  .........  .........  .........          -5    ............         +5   ...........          -5          +5   2d phase for 5 pct.
 Do...........................................        46          5         41           41             4            5          50            45           5
Aug. 1, 1981..................................       -22         -5        -17          -17    ............         -5         -22           -17          -5   F sells 22 pct.
 Do...........................................        24          0         24           24             4            0          28            28           0
June 1, 1982..................................  .........  .........  .........         -24    ............        +24   ...........         -24         +24   2d phase for 24 pct.
 Do...........................................        24          0         24            0             4           24          28             4          24
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 4. (i) On May 26, 1969, F, a private foundation, owns 30 
percent of the voting stock in P Corporation (voting power and value), 
and disqualified persons own 20 percent. On May 1, 1971, D, a 
disqualified person, dies leaving 18 percent of the voting stock to F. 
Assume that distribution was made on June 1, 1972, and that section 4943 
(c)(5) applies. On May 26, 1969, the substituted combined voting level 
and the disqualified person voting level are each 50 percent and the 
permitted holdings are 0 percent (50%-50%). On May 1, 1971, and June 1, 
1972, these levels remain unchanged. On May 1, 1971, the 18 percent 
interest is treated as held by a disqualified person for a period 
extending through May 31, 1982. On May 26, 1979, the foundation voting 
level increases to 30 percent, the disqualified person voting level 
decreases to 20 percent (50%-30%), and the permitted holdings are 30 
percent (50%-20%). On June 1, 1982, the foundation voting level 
increases to 48 percent, the disqualified person voting level decreases 
to 2 percent and the permitted holdings are 48 percent (50%-2%). Since 
at no time during the second phase for F's 1969 holdings did all 
disqualified persons together have holdings in excess of 2 percent of 
the voting stock of P, the 25 percent limitation of section 
4943(c)(4)(D)(i) did not apply to F's 1969 holdings.
    (ii) On July 1, 1993, F disposes of 16 percent of the stock in P, 
thereby reducing the substituted combined voting level to 34 percent 
(50%-16%), and reducing the permitted holdings to 32 percent (34%-2%). 
If F had not disposed of the 16 percent of the stock of P prior to May 
26, 1994, on such date, under section 4943(c)(4)(D)(ii), F's substituted 
combined voting level for its 1969 holdings would have been 35 percent, 
and the permitted holdings would have been 33 percent (35%-2%). Since 
none of F's holdings of 48 percent would have been treated as held by a 
disqualified person on such date (the beginning of the third phase for 
F's 1969 holdings), F would have had excess business holdings of 15 
percent, the lesser of 30 percent (F's 1969 holdings in the third 
phase), of 15 percent (the excess of F's 48 percent holdings over the 
permitted holdings of 33 percent).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                  F owns    interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1971    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)   (percent)
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................        30         30   .........          30            20            0          50            50           0
May 1, 1971...................................       +18   .........       +18          +18           -18    ..........  ...........  ............  .........  D dies.
 Do...........................................        48         30         18           48             2            0          50            50           0
June 1, 1972..................................        48         30         18           48             2            0          50            50           0   Distribution.
May 26, 1979..................................  .........  .........  .........         -30    ............        +30   ...........         -30         +30   2d phase for 30 pct.
 Do...........................................        48         30         18           18             2           30          50            20          30
June 1, 1982..................................  .........  .........  .........         -18    ............        +18   ...........         -18         +18   2d phase for 18 pct.
 Do...........................................        48         30         18            0             2           48          50             2          48
July 1, 1993..................................       -16        -16   .........  ............  ............        -16         -16    ............       -16   F disposes of 16 pct.
 Do...........................................        32         14         18            0             2           32          34             2          32

[[Page 142]]

 
May 26, 1994..................................        32         14         18            0             2           32          34             2          32   3d phase for 14 pct.
June 1, 1997..................................        32         14         18            0             2           32          34             2          32   3d phase for 18 pct.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 5. (i) On May 26, 1969, F, a private foundation, owns 5 
percent of the voting stock in Q Corporation (voting power and value), 
and disqualified persons own 45 percent. On May 1, 1971, E, a 
disqualified person, dies leaving 43 percent of the voting stock to F. 
Assume that distribution was made on June 2, 1972, and that section 
4943(c)(5) applies. On May 26, 1969, the substituted combined voting 
level and the disqualified person voting level are each 50 percent and 
the permitted holdings are 0 percent (50%-50%). On May 1, 1971, and June 
1, 1972, these levels remain unchanged. On May 1, 1971, the 43 percent 
interest is treated as held by a disqualified person for a period 
extending through May 31, 1982. On May 26, 1979, the foundation voting 
level increases to 5 percent, the disqualified person voting level 
decreases to 45 percent, and the permitted holdings are 5 percent (50%-
45%). On June 1, 1982, the foundation voting level increases to 48 
percent, the disqualified person voting level decreases to 2 percent, 
and the permitted holdings are 48 percent (50%-2%). At no time during 
the second phase for F's 1969 holdings did all disqualified persons 
together have holdings in excess of 2 percent of the voting stock of Q. 
Therefore, the 25 percent limitation of section 4943(c)(4)(D)(i) did not 
apply.
    (ii) On July 1, 1993, F sells 6 percent of the stock in Q to a 
nondisqualified person. This reduces the substituted combined voting 
level to 44 percent and reduces the permitted holdings to 42 percent 
(44%-2%). If F had not disposed of the 6 percent of the stock in 1993, 
on May 26, 1994, at the beginning of the third phase for F's 1969 
holdings, F would have had 5 percent excess business holdings. The 
excess business holdings are 5 percent because although the excess 
business holdings computed for the third phase are 15 percent (the 
excess of F's actual holdings (48%) over the permitted holdings of 33 
percent (35%-2%)), only 5 percent of the holdings are in this phase and 
subject to the 35 percent combined holdings limitation.
    (iii) On July 1, 1995, F sells 10 percent of the stock in Q, thereby 
reducing the substituted combined voting level to 34 percent and 
reducing the permitted holdings to 32 percent (34%-2%). If F had not 
disposed of the 10 percent of the stock, on June 1, 1997, at the 
beginning of the third phase for F's acquired holdings, F would have had 
9 percent excess business holdings (the excess of F's total holdings in 
the third phase (42%) over the permitted holdings of 33 percent (35%-
2%)).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                 F's owns   interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1971    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)   (percent)
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................         5          5   .........           5            45            0          50            50           0
May 1, 1971...................................       +43   .........       +43          +43           -43    ..........  ...........  ............  .........  E dies.
 Do...........................................        48          5         43           48             2            0          50            50           0
June 1, 1972..................................        48          5         43           48             2            0          50            50           0   Distribution.
May 26, 1979..................................  .........  .........  .........          -5    ............         +5   ...........          -5          +5   2d phase for 5 pct
 Do...........................................        48          5         43           43             2            5          50            45           5
June 1, 1982..................................  .........  .........  .........         -43    ............        +43   ...........         -43         +43   2d phase for 43 pct.
 Do...........................................        48          5         43            0             2           48          50             2          43
July 1, 1993..................................        -6         -5         -1   ............  ............         -6          -6    ............        -6   F sells 6 pct.
 Do...........................................        42          0         42            0             2           42          44             2          42
July 1, 1995..................................       -10   .........       -10   ............  ............        -10         -10    ............       -10   F sells 10 pct.

[[Page 143]]

 
 Do...........................................        32          0         32            0             2           32          34             2          32
June 1, 1997..................................        32          0         32            0             2           32          34             2          32   3d phase for 32 pct.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 6. (i) On May 26, 1969, F, a private foundation, owns 30 
percent of the voting stock in R Corporation (voting power and value), 
and disqualified persons own 20 percent. On August 1, 1978, F disposes 
of 6 percent of the stock to a nondisqualified person. On May 1, 1981, 
G, a disqualified person, dies leaving 15 percent of the voting stock to 
F. Assume that distribution was made on June 1, 1982, and that section 
4943(c)(5) applies. On May 26, 1969, the substituted combined voting 
level and the disqualified person voting level are each 50 percent, and 
the permitted holdings are 0 percent (50%-50%). On August 1, 1978, these 
levels decrease to 44 percent (50%-6%). On May 26, 1979, the foundation 
voting level increases to 24 percent (30%-6%), the disqualified person 
voting level decreases to 20 percent (44%-24%), and the permitted 
holdings are 24 percent (44%-20%). If F had not disposed of the 6 
percent of the stock prior to May 26, 1979, on May 26, 1979, the 
beginning of the second phase for F's 1969 holdings, F's permitted 
holdings would have been 25 percent, the lesser of 25 percent (under 
section 4943(c)(4)(D)(i)) or 30 percent (50%-20%). Since the 30 percent 
interest would no longer have been treated as held by a disqualified 
person on such date, F would have had excess business holdings of 5 
percent (30%-25%).
    (ii) On May 1, 1981, and June 1, 1982 (assuming F had disposed of 
the 6 percent holdings), the foundation voting level, the disqualified 
person voting level, the substituted combined voting level and permitted 
holdings remain respectively 24 percent, 20 percent, 44 percent and 24 
percent. On May 1, 1981, the 15 percent interest is treated as held by a 
disqualified person for a period extending through May 31, 1992. On July 
1, 1991, F sells 16 percent of the voting stock in R to a 
nondisqualified person, thereby reducing the substituted combined voting 
level to 28 percent (44%-16%), and reducing the foundation voting level 
to 8 percent (24%-16%). The disqualified person voting level remains at 
20 percent. On June 1, 1992, at the beginning of the second phase for 
F's holdings acquired by will, the substituted combined voting level 
remains at 28 percent, the foundation voting level increases to 23 
percent (8%+15%) and the disqualified person voting level decreases to 5 
percent (20%-15%). The permitted holdings on such date are 23 percent 
(28%-5%). If F had not disposed of the 16 percent interest prior to June 
1, 1992, F's permitted holdings would have been 25 percent, the lesser 
of 25 percent (under section 4943 (c)(4)(D)(i)) or 39 percent (44%-5%). 
Since as of such date, F's entire holdings of 39 percent would no longer 
have been treated as held by a disqualified person, F would have had 
excess business holdings of 14 percent (39%-25%).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                 F's owns   interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1981    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)   (percent)
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................        30         30   .........          30            20            0          50            50           0
Aug. 1, 1978..................................        -6         -6   .........          -6    ............  ..........         -6            -6    .........  F disposes of 6 pct.
 Do...........................................        24         24   .........          24            20            0          44            44           0
May 26, 1979..................................  .........  .........  .........         -24    ............        +24   ...........         -24         +24   2d phase for 24 pct.
 Do...........................................        24         24   .........           0            20           24          44            20          24
May 1, 1981...................................       +15   .........       +15          +15           -15    ..........  ...........  ............  .........  G dies.
 Do...........................................        39         24         15           15             5           24          44            20          24
June 1, 1982..................................        39         24         15           15             5           24          44            20          24   Distribution.
July 1, 1991..................................       -16        -16   .........  ............  ............        -16         -16    ............       -16   F disposes of 16 pct.
 Do...........................................        23          8         15           15             5            8          28            20           8

[[Page 144]]

 
June 1, 1992..................................  .........  .........  .........         -15    ............        +15   ...........         -15         +15   2d phase for 15 pct.
 Do...........................................        23          8         15            0             5           23          28             5          23
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 7. (i) On May 26, 1969, F, a private foundation, owns 5 
percent of the voting stock in S Corporation (voting power and value), 
and disqualified persons own 45 percent. On May 1, 1980, H, a 
disqualified person, dies leaving 41 percent of the voting stock to F. 
Assume that distribution is made on June 1, 1981, and that section 
4943(c)(5) applies. On May 26, 1969, the substituted combined voting 
level and disqualified person voting levels are each 50 percent. On May 
26, 1979, the disqualified person voting level decreases to 45 percent, 
the foundation voting level increases to 5 percent, and the permitted 
holdings are 5 percent (50%-45%). On May 1, 1980, and June 1, 1981, the 
levels remain the same. Since the 41 percent holdings are treated as 
held by a disqualified person for the period beginning on May 1, 1980, 
and extending through May 31, 1991, F's remaining holdings of 5 percent 
do not exceed the 25 percent limitation of section 4943(c)(4)(D)(i).
    (ii) On August 1, 1990, F sells 22 percent of the voting stock of S 
to a nondisqualified person, reducing the 5 percent foundation voting 
level to zero, leaving 17 percent (22%-5%) to reduce the disqualified 
person voting level to 28 percent (45%-17%) so that the substituted 
combined voting level equals 28 percent (50%-22%). On June 1, 1991, the 
beginning of the second phase for the remaining 24 percent (41%-17%) of 
F's holdings acquired by will, the foundation voting level increases 
from zero to 24 percent, the disqualified person voting level decreases 
to 4 percent (28%-24%), the substituted combined voting level remains at 
28 percent, and the permitted holdings equal 24 percent (28%-4%).
    (iii) If F had not disposed of the 22 percent holdings prior to June 
1, 1991, F's permitted holdings would have been 25 percent, the lesser 
of 25 percent (under section 4943(c)(4)(D)(i)) or 46 percent (50%-4%). 
Since as of such date, F's entire holdings of 46 percent would no longer 
have been treated as held by a disqualified person, F would have had 
excess business holdings of 21 percent (46%-25%).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                  F owns    interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1980    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)    (percent
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................         5          5   .........           5            45            0          50            50           0
 Do...........................................  .........  .........  .........          -5    ............         +5   ...........          -5          +5   2d phase for 5 pct.
May 26, 1969..................................         5          5   .........           0            45            5          50            45           5
May 1, 1980...................................       +41   .........       +41          +41           -41    ..........  ...........  ............  .........  H dies.
 Do...........................................        46          5         41           41             4            5          50            45           5
June 1, 1981..................................        46          5         41           41             4            5          50            45           5   Distribution.
Aug. 1, 1990..................................       -22         -5        -17          -17    ............         -5         -22           -17          -5   F disposes of 22 pct.
 Do...........................................        24          0         24           24             4            0          28            28           0
June 1, 1991..................................  .........  .........  .........         -24    ............        +24   ...........         -24         +24   2d phase for 24 pct.
 Do...........................................        24          0         24            0             4           24          28             4          24
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 145]]



Sec. 53.4943-6  Five-year period to dispose of gifts, bequests, etc.

    (a) In general--(1) Application. (i) Paragraph (6) of section 
4943(c) prescribes transition rules for a private foundation, which, but 
for such paragraph, would have excess business holdings as a result of a 
change in the holdings in a business enterprise after May 26, 1969 
(other than by purchase by such private foundation or by a disqualified 
person) to the extent that section 4943(c)(5) (relating to certain 
holdings acquired under a pre-May 27, 1969, will on trust) does not 
apply.
    (ii) Subparagraph (A) of section 4943(c)(6) applies where, 
immediately prior to a change in holdings described in paragraph 
(a)(1)(i) of this section, the foundation has no excess business 
holdings in such enterprise (determined without regard to section 
4943(c) (4), (5), or (6)). In such a case, the entire interest of the 
foundation in such enterprise (immediately after such change) shall 
(while held by the foundation) be treated as held by a disqualified 
person (rather than by the foundation) during the five-year period 
beginning on the date of such change.
    (iii) Subparagraph (B) of section 4943(c)(6) applies where the 
foundation has excess business holdings in such enterprise (determined 
without regard to section 4943(c) (4), (5), or (6)) immediately prior to 
a change in holdings described in paragraph (a)(1)(i) of this section. 
In such a case, the interest of the foundation in such enterprise 
(immediately after such change) shall (while held by the foundation) be 
treated as held by a disqualified person (rather than the foundation) 
during the five-year period beginning on the date of such change, except 
that if and as soon as any holdings in such enterprise become excess 
business holdings during such period (determined without regard to such 
change (and the resulting application of section 4943(c)(6) to the 
foundation's interest in such enterprise)), such holdings shall no 
longer be treated as held by a disqualified person under this section, 
but shall constitute excess business holdings subject to the initial 
tax. In applying the preceding sentence, if holdings of the foundation 
which (but for such change in holdings (and the resulting application of 
section 4943(c)(6) to the foundation's interest in such enterprise)) 
would be subject to the 25 percent limit prescribed by section 
4943(c)(4)(D) after the expiration of the first phase, such holdings 
shall be treated as subject to such percentage limitation for purposes 
of determining excess business holdings. For example, if a private 
foundation in 1978 has present holdings of 28 percent in a busines 
enterprise to which section 4943(c)(4) applies, and such holdings would 
exceed the 25 percent limit of section 4943(c)(4)(D)(i) on May 26, 1979, 
a gift of 5 percent to the foundation in 1978 of an interest in such 
enterprise shall not prevent the 3 percent (28%-25%) excess over the 25 
percent limit from constituting excess business holdings on May 26, 
1979, if on such date disqualified persons hold more than a 2 percent 
interest in such enterprise (and no other transaction has taken place).
    (2) Acquisitions that are not purchases. Section 4943(c)(6) does not 
apply if a change in holdings in a business enterprise is the result of 
a purchase by the private foundation or a disqualified person. For 
purposes of subparagraph (a) of this paragraph, the term ``purchase'' 
shall not include any acquisition by gift, devise, bequest, legacy, or 
interstate succession. Paragraph (d) of this section provides rules for 
the treatment of increases in holdings received in a readjustment (as 
defined in Sec. 53.4943-7(d)(1)).
    (3) Examples. The provisions of paragraph (a) of this section may be 
illustrated by the following examples:

    Example 1. On January 4, 1985, A, an individual, makes a 
contribution to F, a private foundation, of 200 shares of X Corporation 
common stock. Assume that F had no X stock before January 4, 1985, and 
under section 4943(c)(1) the receipt of the X stock by F would cause 
some or all of the 200 shares of the X stock to be classified as excess 
business holdings. Under the provisions of section 4943(c)(6)(A) and 
this paragraph (a), since the contribution of the X stock to F is a gift 
and not a purchase, the X stock in F's hands is treated as held by 
disqualified persons and not by F through January 3, 1990.
    Example 2. Assume the facts as stated in Example (1) except that F 
receives the X stock as a bequest pursuant to the terms of A's will 
executed on April 1, 1980. A dies on June 3, 1984, and the stock is 
distributed to F on February 16, 1985. As in Example (1), the

[[Page 146]]

bequest of X to F is not a purchase under this paragraph (a). 
Consequently, the X stock in F's hands is treated as held by 
disqualified persons and not by F through February 15, 1990.
    Example 3. On February 1, 1980, F, a private foundation, owns 15 
percent of the voting stock of X Corporation, and disqualified persons 
own 4 percent of the voting stock of X Corporation. On February 2, 1980, 
B, a nondisqualified person, contributes 8 percent of the voting stock 
of X to F in a transaction to which section 4943(c)(5) does not apply. 
Assuming that the 35 percent limit of section 4943(c)(2)(B) does not 
apply, under the provisions of section 4943(c)(6)(A) and paragraph (a) 
of this section the 23 percent voting stock owned by F on such date is 
treated as held by a disqualified person through February 1, 1985, since 
F would have had excess business holdings of 7 percent as a result of 
the contribution (23% actual holdings less 16% (20%-4%) permitted 
holdings). On March 1, 1984, C, another nondisqualified person, 
contributes 6 percent of the voting stock of X Corporation to F. But for 
this second contribution and the resulting application of section 
4943(c)(6) to F's interest in X, F would have excess business holdings 
of 7 percent (23%-16%) within the five-year period beginning on the date 
of such contribution. Accordingly, under section 4943(c)(6)(B) and 
paragraph (a) of this section, all 29 percent (6%+23%) of the stock held 
by F on March 1, 1984, will be treated as held by a disqualified person 
until March 1, 1989, except that 7 percent will cease to be so treated 
on February 2, 1985. If prior to February 2, 1985, no further 
transactions occurred in the stock of X, F would have excess business 
holdings of 7 percent subject to the initial tax, since the amount still 
treated as held by disqualified persons (29%-7%) plus the amount 
actually held by disqualified persons (4%) already exceed 20 percent.

    (b) Special rules for acquisitions by will or trust--(1) In general. 
In the case of an acquisition of holdings in a business enterprise by a 
private foundation pursuant to the terms of a will or trust, the five-
year period described in section 4943(c)(6) and in this section shall 
not commence until the date on which the distribution of such holdings 
from the estate or trust to the foundation occurs. See Sec. 53.4943-
5(b)(1) for rules relating to the determination of the date of 
distribution under the terms of a will or trust. For purposes of this 
subparagraph, holdings in a business enterprise will not be treated as 
acquired by a private foundation pursuant to the terms of a will where 
the holdings in the business enterprise were not held by the decedent. 
Thus, in the case of after-acquired property, this subparagraph shall 
not apply, the five-year period described in section 4943(c)(6) and this 
section shall commence on the date of acquisition of such holdings by 
the estate, and such five-year period may expire prior to the date of 
distribution of such holdings from the estate. To the extent that an 
interest to which section 4943(c)(6) and this paragraph (b)(1) apply is 
constructively held by a private foundation under section 4943(d)(1) and 
Sec. 53.4943-8 prior to the date of distribution, it shall be treated 
as held by a disqualified person prior to such date by reason of section 
4943(c)(6). See Sec. 53.4943-8 for rules relating to constructive 
holdings held in an estate or trust for the benefit of the foundation.
    (2) Special rule for section 4943(c)(5) interests acquired from a 
nondisqualified person. (i) In the case of holdings of a private 
foundation in a business enterprise to which section 4943(c)(5) 
(relating to certain holdings acquired under a pre-May 27, 1969, will or 
trust) applies which are acquired from a nondisqualified person, the 
interest of the foundation in such enterprise (immediately after such 
acquisition) shall (while held by the foundation) be treated as held by 
a disqualified person (rather than the foundation) under section 
4943(c)(6)(B) and paragraph (a)(1)(iii) of this section from the date of 
acquisition until the end of the fifth year following the date of 
distribution of such holdings. Thereafter, only the holdings to which 
section 4943(c)(5) and Sec. 53.4943-5(a)(1) apply shall continue to be 
treated as held by a disqualified person until the end of the first 
phase with respect thereto.
    (ii) The provisions of paragraph (b)(2)(i) of this section may be 
illustrated by the following examples:

    Example 1. On May 26, 1969, F, a private foundation, owns 5 percent 
of the voting stock of Corporation X and no disqualified persons own any 
stock in X. On June 30, 1977, a nondisqualified person bequeaths to F 33 
percent of the voting stock in X to which section 4943(c)(5) applies. 
This 33 percent interest is distributed to F on August 17, 1978. Under 
section 4943(c)(6)(A) the entire 38 percent (5%+33%) of the X voting 
stock shall be treated as held by a disqualified person from June 30, 
1977 (the date the 33 percent interest

[[Page 147]]

is contructively acquired by F) until August 17, 1983 (five years after 
the date of distribution of the 33 percent interest to F). However, 
assuming that the 35 percent limit of section 4943(c)(2)(B) does not 
apply, the substituted combined voting level on June 30, 1977 is only 33 
percent because there was no interest to which section 4943(c) (4) or 
(5) applied immediately before that date and thus there was no 
substituted combined voting level at that time. In that case, since the 
3-phase holding period is only available for the interest acquired by 
will (33%) under section 4943(c)(5), the substituted combined voting 
level on June 30, 1977 is only 33 percent, not 38 percent. Assuming that 
the substituted combined voting level remains 33 percent at all relevant 
times, and prior to August 17, 1983, no further transactions occur in 
the stock of X, F on that date would have excess business holdings of 5 
percent subject to the initial tax. The amount treated as held by 
disqualified persons at that time (33%) would equal the substituted 
combined voting level at that time (33%), and thus permitted holdings 
would be zero. Under section 4943(c)(5) the 33 percent interest will 
continue to be treated as held by a disqualified person until August 17, 
1988 (10 years after the date of distribution).
    Example 2. On May 26, 1969, F, a private foundation, owns 29 percent 
of the stock (voting power and value) of Corporation X, and on June 30, 
1977, a nondisqualified person bequeaths to F 23 percent of the stock 
(voting power and value) in X to which section 4943(c)(5) does apply. 
This 23 percent interest is distributed to F on August 17, 1978. 
Disqualified persons hold no stock of X. Although the substituted 
combined voting and value levels cannot exceed 50 percent on May 26, 
1979 (at the start of the second phase with respect to the 29 percent 
interest), under section 4943(c)(6)(B) the entire 52 percent (29%+23%) 
of the X voting stock shall be treated as held by a disqualified person 
from June 30, 1977 (the date the 23% interest is constructively acquired 
by F) until August 17, 1983 (five years after the date of distribution 
of the 23% interest to F). On June 1, 1980, during such second phase, D, 
a disqualified person, purchases 3 percent of the X stock (voting power 
and value). On such date, but for the acquisition by F of the 23 percent 
interest, F would have had excess business holdings of 4 percent. The 
purchase by D of more than 2 percent of the voting stock of X causes the 
25 percent limit of section 4943(c)(4)(D)(i) to apply to the 29 percent 
interest (29%-25%=4%). Thus, on June 1, 1980, 4 percent of the X voting 
stock held by F since May 27, 1969, shall cease to be treated as held by 
a disqualified person under section 4943(c)(6)(B) and become excess 
business holdings subject to the initial tax. See Sec. 53.4943-
2(a)(1)(ii) for the 90-day period in which to dispose of these excess 
business holdings resulting from the purchase by the disqualified 
person.

    (c) Exceptions. (1) Section 4943(c)(6) and this section shall not 
apply to any transfer of holdings in a business enterprise by one 
private foundation to another private foundation which is related to the 
first foundation within the meaning of section 4946(a)(1)(H).
    (2) Section 4943(c)(6) and this section shall not apply to an 
increase in the holdings of a private foundation in a business 
enterprise that is part of a plan whereby disqualified persons will 
purchase additional holdings in the same enterprise during the five-year 
period beginning on the date of such change, e.g., to maintain control 
of such enterprise, since such increase shall be treated as caused in 
part by the purchase of such additional holdings.
    (3) The purchase of holdings by an entity whose holdings are treated 
as constructively owned by a foundation, its disqualified persons, or 
both, under section 4943(d)(1) shall be treated as a purchase by a 
disqualified person if the foundation, its disqualified persons or both 
have effective control of the entity or otherwise can control the 
purchase. For example, if a foundation is the beneficiary of a specific 
bequest of $20,000 and its consent is required for the estate to make a 
purchase using such cash, then a purchase by the estate using such cash 
would be treated as a purchase by a disqualified person. Similarly, if 
an executor of an estate is a disqualified person with respect to a 
private foundation, any purchase by the estate would be treated as a 
purchase by a disqualified person.
    (4) If a private foundation, its disqualified persons, or both, hold 
an interest in specific property under the terms of a will or trust, and 
if the private foundation, its disqualified persons, or both, consent or 
otherwise agree to the substitution of holdings in a business enterprise 
for such specific property, such holdings shall be treated as acquired 
by purchase by a disqualified person. For example, if a private 
foundation is the beneficiary of a specific bequest of $20,000 and the 
private foundation agrees to accept certain of the estate's holdings in 
a business enterprise in satisfaction of such

[[Page 148]]

specific bequest, such holdings will be treated as acquired by purchase 
by a disqualified person even if such holdings were held by the 
decedent.
    (d) Readjustments and distributions--(1) General rule. Except as 
otherwise provided in subparagraph (2) of this paragraph, any increase 
in holdings in a business enterprise that is the result of a 
readjustment (as defined in Sec. 53.4943-7(d)(1)) shall be treated as 
acquired other than by purchase. However, holdings that are attributable 
to holdings owned by the private foundation that would have been excess 
business holdings except for the fact that such holdings were treated as 
held by a disqualified person prior to the readjustment shall in no 
event be treated as held by a disqualified person after the date on 
which the holdings to which the change is attributable would have ceased 
to be treated as held by a disqualified person.
    (2) Exceptions. Any increase in holdings in a business enterprise 
that is the result of a readjustment (as defined in Sec. 53.4943-
7(d)(1)), including any change resulting from application of the rule in 
Sec. 53.4943-8(c)(3), shall be treated as occurring by purchase by a 
disqualified person:
    (i) To the extent the increase is attributable to holdings that were 
excess business holdings prior to the readjustment, and separately
    (ii) To the full extent of the increase if the readjustment includes 
a prohibited transaction, unless the foundation establishes to the 
satisfaction of the Commissoner that effective control of all parties to 
the transaction was, at the time of the transaction, in one or more 
persons (other than the foundation) who are not disqualified persons 
with respect to the foundation. See Sec. 53.4943-7(d)(2) for the 
definition of prohibited transaction.
    (3) Section 4943(c)(6) holdings. If, immediately prior to a 
readjustment (as defined in Sec. 53.4943-7(d)(1)), a private foundation 
has holdings in a business enterprise that are treated under section 
4943(c)(6) as held by a disqualified person, then any holdings in a 
business enterprise that are received in the readjustment in exchange 
for such section 4943(c)(6) holdings shall be treated as the holdings 
surrendered in the exchange to the same extent as provided in Sec. 
53.4943-7 with respect to exchanges involving holdings to which section 
4943(c) (4) or (5) applies. Rules similar to those in Sec. 53.4943-
7(a)(2) shall be applied to determine when holdings are treated as 
surrendered or received in a readjustment for purposes of this 
paragraph.
    (4) Redemption by a corporation that is a disqualified person. If a 
foundation holds an interest in a corporation that is a disqualified 
person, an increase in the holdings of the private foundation, its 
disqualified person, or both, as a result of a redemption or a purchase 
of stock of the disqualified person corporation by such corporation 
shall not be treated as acquired by purchase by a disqualified person 
based solely on the status of the corporation as a disqualified person.
    (5) One percent rule for redemptions. If the holdings of a 
foundation, its disqualified persons, or both, in a business enterprise 
are increased as a result of one or more redemptions during any taxable 
year then, unless the aggregate of such increases equals or exceeds one 
percent of the outstanding voting stock or one percent of the value of 
all outstanding shares of all classes of stock, the determination of 
whether such increases cause the foundation to have excess business 
holdings shall be made only at the close of the private foundation's 
taxable year. The five-year period described in section 4943(c)(6) or 
the 90-day period described in Sec. 53.4943-2(a)(1)(ii), whichever is 
applicable, shall begin on the last day of such taxable year. If, 
however, the aggregate of such increases equals or exceeds one percent 
of the outstanding voting stock or one percent of the value of all 
outstanding shares of all classes of stock, the determination of whether 
such increases cause the foundation to have excess business holdings 
shall be made, and the applicable five-year or 90-day period shall 
begin, as of the date the increases, in the aggregate, equal or exceed 
one percent.
    (6) Examples. The provisions of this paragraph are illustrated in 
Sec. 53.4943-7(f) and by the following examples:

    Example 1. (i) F, a private foundation, holds 20% of the voting 
stock of X corporation, an active business enterprise. No disqualified

[[Page 149]]

person with respect to F holds any X stock. In 1980, X redeems 10% of 
its outstanding shares, increasing F's holdings to 22% of the X stock. 
Assume the redemption by X is not a prohibited transaction.
    (ii) All of F's holdings before the redemption are permitted 
holdings under section 4943(c)(2). There is no effective control of X by 
third parties so the 35% permitted holdings rule is inapplicable. F's 
holdings after the redemption exceed the permitted holdings under 
section 4943 (c)(2) (20%). Because the increase is attributable to stock 
that was permitted holdings prior to the readjustment, and the 
readjustment does not involve a prohibited transaction, the 2% increase 
in F's holdings of X stock is treated as acquired other than by 
purchase. Therefore, under section 4943(c)(6) and this section, F will 
have 5 years from the date of the redemption to dispose of the 2% 
excess.
    Example 2. (i) Assume the same facts as in Example (1) except that 
the 20% of X stock held by F was donated by X corporation, was worth 
more than $5,000 and represented 20% of the contributions received by 
the foundation through the end of the taxable year in which the gift of 
stock was made.
    (ii) X corporation is a disqualified person with respect to F under 
section 4946(a)(1)(A). Under subparagraph (4), the redemption of X stock 
is not treated as a purchase by a disqualified person merely because X 
is a disqualified person with respect to F. Therefore the rules of this 
paragraph apply as if the redemption were made by a corporation which is 
not a disqualified person. The analysis and result are the same as in 
Example (1).
    Example 3. (i) On May 1, 1990, F, a private foundation, received a 
donation of 40% of the stock of X corporation, a business enterprise. 
Neither F nor any disqualified person with respect to F holds any other 
interest in X. On June 1, 1992, the X corporation redeemed F's 40% 
interest in exchange for 100% of the stock of Y corporation, a wholly-
owned subsidiary of X. Assume the redemption by X is not a prohibited 
transaction.
    (ii) Under section 4943(c)(6), the X stock acquired by gift is 
treated as held by disqualified persons through April 30, 1995. Under 
subparagraph (3) of this paragraph (d), 40% of the 100% interest in Y 
received in exchange for F's 40% interest in X is treated as F's 40% 
interest in X and is therefore treated as held by disqualified persons 
through April 30, 1995. In addition, under subparagraph (1) of this 
paragraph (d), the 60% interest in Y that represents an increase in 
holdings above the 40% held before the readjustment will be treated as 
acquired other than by purchase. However, F's 20% interest in X in 
excess of 20% permitted holdings under 4943(c)(2) would have been excess 
business holdings if such interest had not been treated as held by as 
disqualified person on June 1, 1992. Therefore, to the extent of a 30% 
interest in Y, (i.e. , the portion of the increased holdings in Y 
attributable to F's 20% holdings in X) the increased holdings will be 
treated as held by disqualified person only through April 30, 1995, 
since this is the latest date on which F's original 40% interest in X 
would have been treated as held by disqualified persons. The remaining 
30% interest in Y will be treated as held by disqualified persons for 
five years from the date of the exchange (through May 31, 1997).

    (e) Constructive holdings. Any change in holdings in a business 
enterprise that occurs because a corporation ceases to be actively 
engaged in a trade or business, thus causing its holdings to be 
constructively owned by its shareholders, shall be treated as acquired 
other than by purchase.
    (f) Certain transactions treated as purchases; cross references. For 
the application of section 4943(c)(6) to holdings that were not an 
interest in a business enterprise when acquired but that subsequently 
become holdings in a business enterprise, see Sec. 53.4943-10(d)(2).

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR 
6479, Feb. 22, 1984]



Sec. 53.4943-7  Special rules for readjustments involving grandfathered
holdings.

    (a) General rules--(1) Readjustments. Except to the extent provided 
in paragraph (b) of this section, if a private foundation, its 
disqualified persons, or both together have holdings in a corporation to 
which section 4943(c) (4) or (5) applies, stock of a corporation 
received by the foundation, its disqualified persons, or both together 
in a readjustment (as defined in paragraph (d)(1) of this section) in 
exchange for such holdings to which section 4943 (c) (4) or (5) applies 
shall be treated, for purposes of section 4943 (c) (4) or (5), as the 
stock surrendered in the exchange.
    (2) No exchange necessary. Paragraph (a)(1) of this section shall 
apply to all readjustments even if no exchange occurs. For purposes of 
this section, all stock held (directly or indirectly) before a 
readjustment in any corporation involved in the readjustment shall be 
treated as stock surrendered in the readjustment and all stock held 
(directly or indirectly) after the readjustment in

[[Page 150]]

any corporation involved in the readjustment shall be treated as stock 
received in the readjustment in exchange for the stock treated as 
surrendered.
    (b) Exceptions and limitations--(1) Limitation on increases in 
percentage of voting stock. (i) If the percentage of voting stock in a 
business enterprise owned (directly or indirectly) by a private 
foundation by reason of its ownership of stock received in an exchange 
described in paragraph (a) of this section exceeds the greatest 
percentage of voting stock in any business enterprise owned (directly or 
indirectly) by the private foundation prior to such exchange by reason 
of its ownership of the stock surrendered by it in the exchange, then:
    (A) That portion of the stock received by the private foundation in 
the exchange which represents such excess is to be treated as an 
increase in the holdings of the private foundation in accordance with 
Sec. 53.4943-6 (d), and
    (B) Only the remaining portion of the stock received by the private 
foundation in the exchange shall be treated as the stock surrendered by 
the private foundation in the exchange.
    (ii) If the sum of the percentage of voting stock in a business 
enterprise owned (directly or indirectly) by disqualified persons by 
reason of their ownership of stock received in an exchange described in 
paragraph (a) of this section plus the percentage of voting stock in the 
business enterprise owned (directly or indirectly) by the private 
foundation by reason of its ownership of stock received in the exchange 
and treated as the stock surrendered under paragraph (b) (1) (i) of this 
section exceeds the greatest percentage of voting stock in any business 
enterprise owned (directly or indirectly) by the private foundation and 
its disqualified person in combination by reason of their ownership of 
the stock surrendered by them in the exchange, then:
    (A) That portion of the stock received by the disqualified persons 
in the exchange which represents such excess is to be treated as an 
increase in the holdings of the disqualified persons in accordance with 
Sec. 53.4943-6(d), and
    (B) Only the remaining portion of the stock received by the 
disqualified persons in the exchange is to be treated as the stock 
surrendered by the disqualified persons in the exchange.
    (2) Limitation on increase in percentage of value. (i) If the 
percentage of value of all outstanding shares of all classes of stock in 
a business enterprise owned (directly or indirectly) by a private 
foundation by reason of its ownership of stock received in an exhange 
described in paragraph (a) of this section exceeds the greatest 
percentage of such value in any business enterprise owned (directly or 
indirectly) by the private foundation prior to such exchange by reason 
of its ownership of the stock surrendered by it in the exchange, then:
    (A) That portion of the stock received by the private foundation in 
the exchange which represents such excess is to be treated as an 
increase in the holdings of the private foundation in accordance with 
Sec. 53.4943-6(d), and
    (B) Only the remaining portion of the stock received by the private 
foundation in the exchange shall be treated as the stock surrendered by 
the private foundation in the exchange.
    (ii) If the sum of the percentage of value of all outstanding shares 
of all classes of stock in a business enterprise owned (directly or 
indirectly) by disqualified persons by reason of their ownership of 
stock received in an exchange described in paragraph (a) of this section 
plus the percentage of such value in the business enterprise owned 
(directly or indirectly) by the private foundation by reason of its 
ownership of stock received in the exchange and treated as the stock 
surrendered under paragraph (b)(2)(i) of this section exceeds the 
greatest percentage of such value in any business enterprise owned 
(directly or indirectly) by the private foundation and its disqualified 
persons in combination prior to the exchange by reason of their 
ownership of the stock surrendered by them in the exchange, then:
    (A) That portion of the stock received by the disqualified persons 
in the exchange which represents such excess is to be treated as an 
increase in the holdings of the disqualified persons in accordance with 
Sec. 53.4943-6(d), and
    (B) Only the remaining portion of the stock received by the 
disqualified persons in the exchange is to be treated as

[[Page 151]]

the stock surrendered by the disqualified persons in the exchange.
    (3) Increases in percentage of both voting stock and value. (i) If, 
as the result of an exchange described in paragraph (a) of this section, 
a private foundation has excesses determined under both paragraphs 
(b)(1)(i) and (b)(2)(i) of this section, then:
    (A) That portion of the stock received by the private foundation in 
the exchange that represents the larger excess is to be treated as an 
increase in the holdings of the private foundation in accordance with 
Sec. 53.4943-6(d), and
    (B) Only the remaining portion of the stock received by the private 
foundation in the exchange is to be treated as the stock surrendered by 
the private foundation in the exchange.
    (ii) If as the result of an exchange described in paragraph (a) of 
this section, disqualified persons have excesses determined under both 
paragraphs (b)(1)(ii) and (b)(2)(ii) of this section, then:
    (A) That portion of the stock received by the disqualified persons 
in the exchange that represents the larger excess is to be treated as an 
increase in the holdings of the disqualified persons in accordance with 
Sec. 53.4943-6(d), and
    (B) Only the remaining portion of the stock received by disqualified 
persons in the exchange is to be treated as the stock surrendered by 
disqualified persons in the exchange.
    (4) Exception for prohibited transactions. If a readjustment 
includes a prohibited transaction, as defined in paragraph (d)(2) of 
this section, then this paragraph shall be applied substituting, for 
purposes of paragraph (b)(1) and (b)(2), the lowest percentage of voting 
power or value owned prior to the exchange in any business enterprise 
involved in the readjustment to which the exchange relates for the 
greatest percentage of voting power or value in any business enterprise 
owned by reason of ownership of the stock surrendered in the exchange.
    (5) Voting and value levels. After an exchange described in 
paragraph (a) of this section, the private foundation voting and value 
levels, and the substituted combined voting and value levels (as defined 
in Sec. 53.4943-4(d)(2)) shall be the lesser of each respective level 
immediately prior to the exchange with respect to the stock surrendered 
in the exchange and each such respective level determined immediately 
after the exchange by taking into account only the stock received in the 
exchange that is treated under this paragraph as the stock surrendered 
in the exchange. If the stock of more than one corporation is 
surrendered in exchange for stock of one corporation, the highest of 
each voting or value level determined immediately prior to the exchange 
with respect to the stock of the corporations surrendered in the 
exchange shall be treated as such level immediately prior to the 
exchange.
    (6) Determination of phases--(i) In general. Stock received in an 
exchange described in paragraph (a) of this section that is treated as 
stock surrendered in the exchange under this paragraph shall be treated 
as subject to the same first, second, and third phases that were 
applicable to the stock surrendered for it. For purposes of determining 
the applicable phases, stock received in an exchange shall be treated as 
received in exchange for particular holdings of stock surrendered based 
on the terms of the exchange. Where only a portion of the stock received 
is treated as the stock surrendered, such portion of the stock received 
shall be treated as exchanged for particular holdings of stock 
surrendered in the same proportions as the total stock received was 
exchanged for particular holdings of stock surrendered. For example, if 
20 shares of X stock owned by a private foundation, subject to a first 
phase beginning on January 1, 1978 and ending on December 31, 1987, are 
exchanged for 20 shares of Y stock, and 40 shares of X stock owned by 
the private foundation, subject to a first phase beginning on June 1, 
1980 and ending on May 31, 1990, are exchanged for 40 shares of Y stock, 
then \1/3\ of the Y stock received by the private foundation is treated 
as received in exchanged for X stock having the January 1, 1978-December 
31, 1987 first phase and \2/3\ of the Y stock received by the private 
foundation is treated as received in exchange for the X stock having the 
June 1, 1980-May 31, 1990 first phase. If only 30 shares of the Y stock 
received by the private foundation are treated as the

[[Page 152]]

stock surrendered, then \1/3\ (10 Y shares) will be subject to the 
January 1, 1978-December 31, 1987 first phase and \2/3\ (20 Y shares) 
will be subject to the June 1, 1980-May 31, 1990 first phase.
    (ii) Transitional rule. In any case in which holdings subject to 
section 4943(c)(4) or 4943(c)(5) have been consolidated prior to May 22, 
1984, then the longest first phase applicable to any of the holdings 
surrendered in the consolidation shall be applied to the holdings 
received by the foundation in the consolidation that are treated as the 
holdings surrendered in the consolidation. For purposes of this clause, 
a consolidation is any readjustment that results in a reduction in the 
number of entities in which the foundation has direct holdings.
    (c) Plan to dispose of excess business holdings. (1) Notwithstanding 
Sec. 53.4943-4(d)(i)(4)(D) (relating to restrictions on increases in 
levels) and paragraphs (a) and (b) of this section, if a readjustment 
occurs under an approved plan to dispose of stock to which section 
4943(c) (4) or (5) applies, in order to meet the requirements of section 
4943(c)(4) (i.e., to meet the reduced limits that will be applicable 
after the first phase holding period described in Sec. 53.4943-4(c)) or 
to meet the requirements of section 4943(c)(2), all of the stock 
received in the readjustment shall be treated as held by disqualified 
persons through the end of the longest first phase holding period 
applicable to stock surrendered in the readjustment. The foundation and 
substituted combined voting and value levels shall not be increased on 
account of the readjustment.
    (2) For purposes of this paragraph, a plan is an approved plan only 
if it is approved by the Commissioner and may be subject to such 
conditions as the Commissioner determines. A plan must be approved prior 
to any exchange or distribution pursuant to the plan except for a 
showing of good cause such as a business emergency.
    (d) Definitions--(1) Readjustments. For purposes of this section, 
the term ``readjustment'' includes, but is not limited to:
    (i) A merger or consolidation;
    (ii) A recapitalization;
    (iii) An acquisition of stock or assets;
    (iv) A transfer of assets;
    (v) A change in identity, form, or place of organization, however 
effected;
    (vi) A redemption;
    (vii) A distribution of assets or of stock, including a distribution 
to which section 301, 302, 331, or 355 applies or a distribution of 
stock of the distributing corporation.
    (2) Prohibited transaction. A prohibited transaction is any 
transaction involving a private foundation that has holdings in a 
business enterprise which:
    (i) Acquires stock (or similar interest in the case of an 
unincorporated entity) or assets of a business enterprise or redeems its 
own stock (or similar interest in the case of an unincorporated entity) 
using cash or other property transferred to the acquiring business 
enterprise (e.g., as a contribution to capital) by the private 
foundation, its disqualified persons, or both;
    (ii) Acquires stock (or similar interest in the case of an 
unincorporated entity) or assets of a business enterprise or redeems its 
own stock (or similar interest in the case of an unincorporated entity) 
using the proceeds of a loan made to, or guaranteed by, the private 
foundation, its disqualified persons, or both;
    (iii) Acquires 40 percent or more of the voting stock (or similar 
interest in the case of an unincorporated entity), 40 percent or more of 
the value of all outstanding shares of all classes of stock (or similar 
interest in the case of an unincorporated entity), or 40 percent or more 
of the assets of a business enterprise if the acquiring business 
enterprise's net assets used in its trade or business prior to such 
acquisition are insubstantial when compared to the net assets acquired 
or when compared to the net assets of the business enterprise, the stock 
(or similar interest in the case of an unincorporated entity) of which 
was acquired. For this purpose, an insubstantial ratio means a ratio 
that is 15% or less; or
    (iv) Is used as a device to acquire or expand excess business 
holdings. The determination of whether a business enterprise is used as 
a device to acquire or expand excess business holdings shall be 
determined based on all the

[[Page 153]]

facts and circumstances. A business enterprise shall be presumed to have 
been used as a device to acquire or expand excess business holdings if 
it acquires 40 percent or more of the voting stock (or similar interest 
in the case of an unincorporated entity), 40 percent or more of the 
value of all outstanding shares of all classes of stock (or similar 
interest in the case of an unincorporated entity), or 40 percent or more 
of the assets of a business enterprise if the consideration for the 
acquisition consists primarily of nonvoting stock (or similar interest 
in the case of an unincorporated entity) of the acquiring business 
enterprise.
    (3) Corporation involved in a readjustment. A corporation shall be 
treated as involved in a readjustment if, as part of the readjustment, 
any stock of the corporation is issued or redeemed, or any stock or 
assets of the corporation are distributed, exchanged, purchased, sold, 
acquired, or otherwise transferred.
    (e) Application to unincorporated business enterprise. The rules of 
this section shall apply equally to partnerships and other 
unincorporated business enterprises, applying the rules and 
substitutions provided in Sec. 53.4943-3(c)(2), (3), and (4).
    (f) Examples. The provisions of this section and Sec. 53.4943-6(d) 
are illustrated by the following examples, which assume no prohibited 
transactions are involved unless otherwise stated:

    Example 1. (i) F, a private foundation, has owned 80% of the one 
outstanding class of stock of X corporation since 1965. The X is subject 
to section 4943(c)(4) with a first phase ending on May 25, 1984. On 
January 1, 1982, X merges with Y corporation to form Z corporation. X, 
Y, and Z are active business corporations. F owns no Y stock. No 
disqualified person with respect to F owns any stock in Y.Y, or Z. After 
the merger, F owns 25% of the one outstanding class of Z stock. Third 
parties do not control Z so that the 35% permitted holdings rule under 
section 4943(c)(2) is inapplicable
    (ii) F's percentage of voting power and value in Z after the merger 
(25%) are less than F's percentages of voting power and value in X 
before the merger (80%). Therefore, under paragraph (a)(1) of this 
section, all of F's holdings in Z are treated as the X stock 
surrendered. Therefore, the Z stock is treated as subject to section 
4943(c)(4) with a first phase ending on May 25, 1984. Under downward 
ratchet of paragraph (a)(5) of this section, the foundation voting and 
value levels and the substituted combined voting and value levels are 
reduced to 25%.
    Example 2. (i) F, a private foundation, owns 100% of the one 
outstanding class of stock in X corporation and 30% of the one 
outstanding class of stock in Y corporation. F has held this stock 
continuously since 1960, and no disqualified person has even owned any 
stock in X or Y. Under section 4943(c)(4), F's holdings in X are treated 
as held by disqualified persons through the end of the first phase on 
May 25, 1989, and F's holdings in Y are permitted holdings during the 
second phase, which began on May 25, 1989, and F's holdings in Y are 
permitted holdings during the second phase, which began on May 26, 1979. 
On January 1, 1985, X and Y consolidate, forming a new corporation Z. In 
the consolidation, F acquires 50% of the one class of outstanding stock 
of Z, 40% in exchange for F's 100% interest in X and 10% in exchange for 
F's 30% interest in Y. Unrelated parties hold the remaining 50% of Z.
    (ii) F's percentage of voting power and value in Z after the merger 
(50%) are less than F's percentages of voting power and value in X 
before the merger (100%). Thus, under paragraph (a)(1) of this section, 
the 50% interest in Z held by F is treated as the stock surrendered in 
the exchange for purposes of section 4943(c)(4). Under paragraph (b)(6) 
of this section, the 10% interest in Z received for the Y stock is 
subject to the same second phase period as the surrendered Y stock. The 
40% interest first phase period as the surrendered X stock.
    Example 3. (i) F, a private foundation, owns 50% of the one class of 
outstanding stock in X corporation which F has held continuously since 
1935. No disqualified person with respect to F owns any stock in X. 
Neither F nor any disqualified person with respect to F owns any stock 
in Y corporation. On July 1, 1982, X and Y enter into an agreement to 
consolidate their businesses in a reorganization to which section 
368(a)(1)(A) will apply. As a result of the contemplated consolidation, 
F will own 60% of the voting stock in Z, the resulting corporation. In 
addition, parties unrelated to F will own the remaining 40% of the Z 
voting stock and 100% of a new issue of nonvoting preferred stock in Z. 
Assume for purposes of this example, that the 60% of the voting stock to 
be held by F in Z will represent 50% of the fair market value of the 
outstanding Z stock.
    (ii) Under the provisions of paragraph (b)(1) of this section, that 
portion of the Z stock held by F which represents a percentage of voting 
power equivalent to that held by F in X immediately prior to the 
consolidation (i.e., 50%) will be treated as the X stock held by F on 
May 26, 1969, for purposes of section 4943(c)(4). Therefore, 50% of the 
Y stock will

[[Page 154]]

be treated as subject to a second phase ending on May 25, 1994. The 
remaining portion of the Z voting stock held by F (10%) is subject to 
the provisions of Sec. 53.4943-6(d)(1). F will have five years from the 
date of the merger in which to dispose of 10% of the Z stock without 
incurring the tax on excess business holdings.
    Example 4. (i) F, a private foundation, owns 80% of the one class of 
outstanding stock in X corporation, an active business corporation. F 
has held this stock continuously since 1960 and no disqualified person 
with respect to F owns any stock in X. X has two operating divisions, 
one which manufacturers shoes and the other which manufactures 
refrigerators. On January 1, 1978, in a section 351(a) exchange, X 
transferred all of the assets of its shoe manufacturing division to Y, a 
corporation which X has formed for this purpose, and receives 100% of 
the stock of Y so that Y is a wholly-owned subsidiary of X. X then 
transfers all of the Y stock to F in exchange for all of F's holdings of 
X stock in a distribution to which section 355 applies.
    (ii) Under paragraph (b)(1) of this section, 80% of the Y stock is 
treated as the X stock surrendered in the exchange for purposes of 
section 4943(c)(4). The 80% is treated under Sec. 53.4943-4(c) as held 
by disqualified persons through May 25, 1984, which constitutes the 15-
year first phase holding period applicable to the 80% holding in X. The 
80% of the Y stock must be reduced to the permitted holdings allowed 
during the second and third phase as provided by section 4943(c)(4)(D) 
in the same manner as F's holdings of X stock would have had to have 
been reduced.
    (iii) Under Sec. 53.4943-6(d)(1), the remaining 20% of Y stock is 
treated as held by a disqualified person for five years from the date of 
the exchange. F will have five years from the date of the exchange in 
which to dispose of 20% of the Y stock without incurring the tax on 
excess business holdings.
    Example 5. (i) X corporation, an active business corporation, has 
outstanding 1,000 shares of one class of stock, of which 600 shares have 
been held by F1, a private foundation; 100 shares have been held by F2, 
another private foundation; and 100 shares have been held by D, a 
disqualified person with respect to both F1 and F2. Unrelated parties 
hold the remaining 200 shares. F1 and F2 are disqualified persons with 
respect to each other under section 4946(a)(1)(H). Thus, F1 holds 60% of 
the X stock (600/1000); F2 and D each hold 10% (100/1000); and the 
foundation group (F1, F2 and D) holds 80% of X (800/1000). The holdings 
of F1 and F2 were acquired on January 1, 1980 pursuant to a pre-1969 
will and are subject to section 4943(c)(5). There have been no changes 
in holdings since January 1, 1980.
    (ii) On January 1, 1985, pursuant to a plan to dispose of excess 
business holdings approved by the Commissioner under paragraph (c) of 
this section, X redeems for cash the 600 shares held by F1. After the 
redemption, D and F2 each hold 25% of X (100/400). F1 no longer holds 
any X stocks. The foundation group's holdings (F1, F2 and D) have 
decreased from 80% to 50% while holdings of unrelated parties have 
increased from 20% to 50%. At the same time F2's and D's holdings each 
have increased from 10% to 25%.
    (iii) Notwithstanding the increase in F2's and D's holdings, under 
paragraph (c) of this section, all of the X stock held by F2 will be 
treated as held by a disqualified person through the end of the first 
phase (December 31, 1994). However, the foundation voting and value 
levels do not increase. Therefore, after the end of the first phase, 
F2's holdings in X may not exceed 10 percent (if the combined holdings 
of F1, F2 and D exceed the permitted holdings under section 4943(c)(2)).
    Example 6. (i) X corporation, an active business corporation, has 
outstanding 1,000 shares of its one class of stock. Since 1960, 100 
shares (10%) have been held by F, a private foundation and 350 shares 
(35%) have been held by D, a disqualified person with respect to F. All 
of the stock held by F is permitted holdings under section 4943(c)(4) 
and the substituted combined voting and value levels are 45% (10% + 
35%). Because of disagreements concerning management of X between D and 
A, an unrelated party who holds 300 shares (30%) of the X stock, X 
redeems all of A's shares on December 1, 1981.
    (ii) After the redemption, F holds 14.3% (100/700) of the X stock 
and D holds 50% (350/700), for combined holdings of 64.3%. Because the 
combined holdings exceed the substituted combined voting level (45%) by 
more than F's entire holdings, all of the F stock is excess business 
holdings. However, all of F's stock will be treated as acquired other 
than by purchase under Sec. 53.4943-6(d)(1) and therefore will be 
treated under section 4943(c)(6) and this section, as held by a 
disqualified person for five years from the date of the redemption 
(through November 30, 1986). If the combined holdings of F and its 
disqualified person are reduced to 45 percent by the end of the five 
year period, F may retain a portion of its holdings in X (limited to no 
more than the foundation voting and value level of 10 percent).
    Example 7. Assume the same facts as in Example (6), except that D 
loaned the money to X that was used to redeem A's shares. Under these 
facts, the increased holdings result from a prohibited transaction 
described in paragraph (d)(2) of this section. Therefore, all of F's 
stock will be treated as acquired by purchase by a disqualified person 
under Sec. 53.4943-6(d)(2). F will have 90 days after the redemption in 
which to dispose of its holdings or to reduce its holdings and the 
combined holdings to the levels held prior to the redemption as 
discussed in Example (6).

[[Page 155]]

    Example 8. (i) F, a private foundation, has held 100% of the 
outstanding stock of X corporation since 1960. F also holds 15% of the 
voting stock of Y corporation. Both X and Y are active business 
corporations. X has $1 million in net assets used in its trade or 
business and Y has $6.7 million used in its trade or business. On June 
1, 1985, Y is merged into X. After the merger F holds 25% of the voting 
stock of X. No person other than F controls X after the merger.
    (ii) Because more than 40% of Y was acquired and the net assets of 
X, the acquiring corporation, used in its trade or business prior to the 
merger represent less than 15% of the net assets of Y used in its trade 
or business, the merger is a prohibited transaction described in 
paragraph (d)(2)(iii). Therefore, only 15% of the stock X is treated, 
pursuant to paragraph (b), as the stock held by F prior to the 
redemption. F's holding of 5% (the excess of F's 25% holdings over the 
20% permitted holdings in X (determined under section 4943(c)(2)) are 
treated as purchased by a disqualified person pursuant to Sec. 53.4943-
6(d)(2). F will have 90 days after June 1, 1985, in which to dispose of 
the 5% excess holdings.

[T.D. 7944, 49 FR 6480, Feb. 22, 1984]



Sec. 53.4943-8  Business holdings; constructive ownership.

    (a) Constructive ownership--(1) In general. For purposes of section 
4943, in computing the holdings in a business enterprise of a private 
foundation, or a disqualified person (as defined in section 4946), any 
stock or other interest owned, directly or indirectly, by or for a 
corporation, partnership, estate or trust shall be considered as being 
owned proportionately by or for its shareholders, partners, or 
beneficiaries except as otherwise provied paragraphs (b), (c) and (d) of 
this section. Any interest in a business enterprise actually or 
constructively owned by a shareholder of a corporation, a partner of a 
partnership, or beneficiary of an estate or trust shall not be 
considered as constructively held by the corporation, partnership, trust 
or estate. Further, if any corporation, partnership, estate or trust has 
a warrant or other option to acquire an interest in a business 
enterprise, such interest is not deemed to be constructively owned by 
such entity until the option is exercised. (See paragraph (b)(2) of 
Sec. 53.4943-3 for rules that options are not stock for purposes of 
determining excess business holdings.)
    (2) Powers of appointment. Any interest in business enterprise over 
which a foundation or a disqualified person has a power of appointment 
exercisable in favor of the foundation or a disqualified person shall be 
considered owned by the foundation or disqualified person holding such 
power of appointment.
    (3) Determination of extent of constructive ownership. If an 
interest in a business enterprise owned by a corporation is 
constructively owned by a shareholder, each shareholder's proportion of 
ownership is generally computed on the basis of the voting stock each 
shareholder has in the corporation. In determining holdings permitted 
under section 4943(c) (4) and (5), each shareholder's proportion of 
ownership in the business enterprise shall also be computed on the basis 
of value, taking into account both voting and nonvoting stock held by 
the shareholder.
    (4) Nonvoting stock. If a private foundation, its disqualified 
persons, or both, own (directly or constructively) nonvoting stock of a 
parent corporation, the holdings of which are treated as constructively 
owned by its shareholders by reason of section 4943(d)(1) and this 
section, such nonvoting stock shall be treated as nonvoting stock of any 
corporation in which the parent corporation holds an interest for 
purposes of the limitation on the holding of nonvoting stock under 
section 4943(c)(2)(A) and Sec. 53.4943-3(b)(2).
    (5) Interests held by certain disqualified persons. In the case of 
an entity that is a disqualified person (other than an entity described 
in section 4946(a)(1)(H)), the holdings of which are treated as 
constructively owned by its shareholders, partners, or beneficiaries, 
for purposes of determining the total holdings of disqualified persons 
the holdings of the entity shall be considered held by a disqualified 
person only to the extent such holdings are treated as constructively 
owned by disqualified persons who are shareholders, partners, or 
beneficiaries of the entity. In the case of an entity described in 
section 4946(a)(1)(H) or an entity, the holdings of which are not 
treated as constructively owned by its shareholders, partners, or 
beneficiaries, all holdings of such entity shall be treated as held by

[[Page 156]]

a disqualified person if and only if the entity itself is a disqualified 
person.
    (b) Estates and trusts--(1) In general. Any interest actually or 
constructively owned by an estate or trust is deemed constructively 
owned, in the case of an estate, by its beneficiaries or, in the case of 
a trust, by its remainder beneficiaries except as provided in paragraphs 
(b) (2), (3) and (4) of this section (relating to certain split-interest 
trusts described in section 4947(a)(2), to trusts of qualified pension, 
profit-sharing, and stock bonus plans described in section 401(a) and to 
revocable trusts). Thus, if a trust owns 100 percent of the stock of a 
corporation A, and if, on an actuarial basis, W's life interest in the 
trust is 15 percent, Y's life interest is 25 percent, and Z's remainder 
interest is 60 percent, under this paragraph (b), Z will be considered 
to be the owner of 100 percent of the stock of corporation A. See Sec. 
53.4943-4, Sec. 53.4943-5 and Sec. 53.4943-6 for rules relating to 
certain actual or constructive holdings of a foundation being treated as 
held by a disqualified person. For the treatment of certain property 
acquired by an estate or trust after May 26, 1969, see paragraph (a)(2) 
of Sec. 53.4943-5.
    (2) Split-interest trusts--(i) Amounts transferred in trust after 
May 26, 1969. In the case of an interest in a business enterprise which 
was transferred to a trust described in section 4947(a)(2) after May 26, 
1969, for the benefit of a private foundation, no portion of such 
interest shall be considered as owned by the private foundation:
    (A) If the foundation holds only an income interest in the trust, or
    (B) If the foundation holds only a remainder interest in the trust 
(unless the foundation can exercise primary investment discretion with 
respect to such interest)

until such trust ceases to be so described. See section 4947(a)(2) and 
(b)(3) and the regulations thereunder for rules relating to such trusts. 
See also sections 4946(a)(1) (G) and (H) and the regulations thereunder 
for rules relating to when a trust described in this paragraph (b)(2) is 
itself a disqualified person.
    (ii) Amounts transferred in trust on or before May 26, 1969. In the 
case of an interest in a business enterprise which was transferred to a 
trust described in section 4947(a)(2) (without regard to section 
4947(a)(2)(C)) on or before May 26, 1969, for the benefit of a private 
foundation, no portion of such interest shall be considered as owned by 
the foundation until it is actually distributed to the foundation or 
until the trust ceases to be so described. See section 4943(c)(5) and 
Sec. 53.4943-5 for rules relating to certain trusts which were 
irrevocable on May 26, 1969.
    (3) Employee benefit trusts. An interest in a business enterprise 
owned by a trust described in section 401(a) (pension and profit-sharing 
plans) shall not be considered as owned by its beneficiaries, unless 
disqualified persons (within the meaning of section 4946) control the 
investment of the trust assets.
    (4) Revocable trusts. An interest in a business enterprise owned by 
a revocable trust shall be treated as owned by the grantor of such 
trust.
    (5) Estates. For purposes of applying section 4943(d)(1) to estates, 
the term ``beneficiary'' includes any person (including a private 
foundation) entitled to receive property of a decedent pursuant to a 
will or pursuant to laws of descent and distribution. However, a person 
shall no longer be considered a beneficiary of an estate when all the 
property to which he is entitled has been received by him, when he no 
longer has a claim against the estate and when there is only a remote 
possibility that it will be necessary for the estate to seek the return 
of property or to seek payment from him by contribution or otherwise to 
satisfy claims against the estate or expenses of administration. When 
pursuant to the preceding sentence, a person (including a private 
foundation) ceases to be a beneficiary, stock or another interest in a 
business enterprise owned by the estate shall not thereafter be 
considered owned by such person. If any person is the constructive owner 
of an interest in a business enterprise actually held by an estate, the 
date of death of the testator or decedent intestate shall be the first 
day on which such person shall be considered a constructive owner of 
such interest. See Sec. 53.4943-5 for rules relating to wills executed 
on or before May 26, 1969.

[[Page 157]]

    (c) Corporation actively engaged in a trade or business--(1) In 
general. Except as provided in paragraphs (c)(2) and (3) of this 
section, any interest (whether or not in a separate entity) owned by a 
corporation which is actively engaged in a trade or business shall not 
be deemed to be constructively owned by such corporation's shareholders.
    (2) Actively engaged in a trade or business. For purposes of 
paragraph (c)(1) of this section:
    (i) A corporation shall not be considerd to be actively engaged in a 
trade or business if the corporation is not a business enterprise by 
reason of section 4943(d)(3) (A) or (B) and Sec. 53.4943-10 (b) or (c);
    (ii) In the case of a corporation which owns passive holdings and is 
actively engaged in a trade or business, such corporation shall not be 
considered to be actively engaged in a trade or business if the net 
assets used in such trade or business are insubstantial when compared to 
passive holdings.
    (3) Exceptions. If a corporation has been involved in a prohibited 
transaction, any interest in a business enterprise owned by such 
corporation shall be treated as constructively owned by its 
shareholders, whether or not such corporation is actively engaged in a 
trade or business. For a definition of prohibited transaction, see Sec. 
53.4943-7 (d)(2).
    (4) Affiliated group. In applying this paragraph to the common 
parent in an affiliated group (as defined in Sec. 53.4943-10 
(c)(3)(ii)), the assets and activities of the affiliated group shall be 
treated as the assets and activities of the common parent.
    (d) Partnerships. Any interest in a business enterprise which is 
owned by a partnership shall be deemed to be constructively owned by the 
partners in such partnerships.
    (e) Examples. The provisions of this section are illustrated by the 
following examples.

    Example 1. F, a private foundation, directly owns voting stock of X, 
a holding company described in section 4943(d)(3)(B). That stock 
represents 40% of the voting power in X and 20% of the value of all 
outstanding shares of all classes of stock in X. F also owns nonvoting 
stock in X that represents 10% of the value of all outstanding shares of 
all classes of stock in X. D, a disqualified person, owns voting stock 
of X that represents 40% of the voting power in X and 20% of the value. 
D does not own any nonvoting stock in X. X corporation's only holding is 
stock of Y corporation. The Y voting stock held by X represents 50% of 
the voting power in Y and 25% of the value of all outstanding shares of 
all classes of stock in Y. X also owns nonvoting stock in Y that 
represents 25% of the value of all outstanding shares of all classes of 
stock in Y. Under paragraph (a)(3) of this section, F and D each 
constructively owns 20% of the voting power in Y through their voting 
interest in X (40% of X's 50% of Y). F also constructively owns 15% of 
the value of all outstanding shares of all classes of stock in Y through 
F's interest in X (F's 30% of the value of X multiplied by X's 50% of 
the value of Y), while D constructively owns 10% of the value of Y (D's 
20% of the value of X multiplied by X's 50% of the value of Y).
    Example 2. (i) F, a private foundation, owns 50% of the one class of 
nonvoting stock of X corporation, a corporation described in section 
4943(d)(3)(B) and paragraph (c)(2)(i) above. D, a disqualified person 
with respect to F as described in section 4946(a)(1)(A), owns 40% of the 
one class of voting stock of X. X corporation is a disqualified person 
with respect to F because D owns more than 35% of the voting of X. (See 
section 4946(a)(1)(E)). On January 1, 1980, X purchases for cash 40% of 
the only class of stock of Y corporation, a retail clothing store, from 
unrelated third parties.
    (ii) Under paragraph (a)(4) of this section, F is treated as owning 
nonvoting stock of Y. Although X is a disqualified person, its holdings 
are not treated as held by disqualified persons except as constructive 
holdings. Therefore, the ``deemed'' nonvoting stock in Y is a permitted 
holding because D, a disqualified person with respect to F, 
constructively owns only 16% of the voting stock of Y (less than 20% 
permitted under section 4943(c)(2)).
    Example 3. (i) The facts are the same as in Example (2), except that 
X purchases 100% of this stock of Y corporation. Under paragraph (a)(4) 
of this section, F is treated as owning nonvoting stock of Y. The 
``deemed'' nonvoting stock in Y is not a permitted holdings because D, a 
disqualified person with respect to F, constructively owns 40% of the 
voting stock of Y.
    Example 4. (i) D, a disqualified person with respect to F, owns 40% 
of the one class of stock in X corporation, an active business. X is a 
disqualified person with respect to F. X acquires 40% of the voting 
stock in Y corporation. Under paragraph (a)(5) of this section, the 
holdings of X in Y are treated as

[[Page 158]]

held by a disqualified person. F cannot hold any Y stock, voting or 
nonvoting.

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR 
6484, Feb. 22, 1984]



Sec. 53.4943-9  Business holdings; certain periods.

    (a) Taxable period--(1) In general. For purposes of section 4943, 
the term ``taxable period'' means, with respect to any excess business 
holdings of a private foundation in a business enterprise, the period 
beginning with the first day on which there are such excess business 
holdings and ending on the earliest of:
    (i) The date of mailing of a notice of deficiency under section 6212 
with respect to the tax imposed on the holdings by the section 4943(a);
    (ii) The date on which the excess is eliminated; or
    (iii) The date on which the tax imposed by section 4943(a) is 
assessed.

For example, M, a private foundation, first has excess business holdings 
in X, a corporation, on February 5, 1972. A notice of deficiency is 
mailed under section 6212 to M on June 1, 1974. With respect to M 's 
excess business holdings in X, the taxable period begins on February 5, 
1972, and ends on June 1, 1974.
    (2) Special rule. Where a notice of deficiency referred to in 
subparagraph (1)(i) of this paragraph is not mailed because there is a 
waiver of the restrictions on assessment and collection of a deficiency, 
or because the deficiency is paid, the date of filing of the waiver or 
the date of such payment, respectively, shall be treated as the end of 
the taxable period.
    (3) Suspension of taxable period for 90 days. In any case in which a 
private foundation has excess business holdings solely because of the 
acquisition of an interest in a business enterprise to which paragraph 
(a)(1) (ii) or (iii) of Sec. 53.4943-2 applies, the taxable period 
described in paragraph (a) of this section shall be suspended for the 
90-day period (as extended) starting with the date on which the 
foundation knows or has reason to know of the acquisition, provided that 
at the end of such period the foundation has disposed of such excess 
holdings.
    (b) Cross reference. For rules relating to taxable events that are 
corrected within the correction period, defined in section 4863(e), see 
section 4861(a) and the regulations thereunder.
    (c) Correction. For purposes of section 4943, correction shall be 
considered as made when no interest in the enterprise held by the 
foundation is classified as an excess business holdings under section 
4943(c)(1). In any case where the private foundation has excess business 
holdings which are constructively held for it under section 4943(c)(1), 
correction shall be considered made when either a corporation, 
partnership, estate, or trust in which holdings in such enterprise are 
constructively held for the foundation or a disqualified person; the 
foundation itself; or a disqualified person disposes of a sufficient 
interest in the enterprise so that no interest in the enterprise held by 
the foundation is classified as excess business holdings under section 
4943(c)(1).

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 8084, 51 FR 
16302, May 2, 1986]



Sec. 53.4943-10  Business enterprise; definition.

    (a) In general. (1) Except as provided in paragraph (b) or (c) of 
this section under section 4943(d)(4) the term ``business enterprise'' 
includes the active conduct of a trade or business, including any 
activity which is regularly carried on for the production of income from 
the sale of goods or the performance of services and which constitutes 
an unrelated trade or business under section 513. For purposes of the 
preceding sentence, where an activity carried on for profit constitutes 
an unrelated trade or business, no part of such trade or business shall 
be excluded from the classification of a business enterprise merely 
because it does not result in a profit.
    (2) Notwithstanding paragraph (a)(1) of this section, a bond or 
other evidence of indebtedness does not constitute a holding in a 
business enterprise unless such bond or evidence of indebtedness is 
otherwise determined to be an equitable interest in such enterprise. 
Similarly, a lease-hold interest in real property does not constitute

[[Page 159]]

an interest in a business enterprise, even though rent payable under 
such lease is dependent, in whole or in part, upon the income or profits 
derived by another from such property, unless such leasehold interest 
constitutes an interest in the income or profits of an unrelated trade 
or business under section 513.
    (b) Certain program-related activities. For purposes of section 
4943(d)(4) the term ``business enterprise'' does not include a 
functionally related business as defined in section 4942(j)(5). See 
Sec. 53.4942(a)-2(c)(3)(iii). In addition, business holdings do not 
include program-related investments (such as investments in small 
businesses in central cities or in corporations to assist in 
neighborhood renovation) as defined in section 4944(c) and the 
regulations thereunder.
    (c) Income derived from passive sources--(1) In general. For 
purposes of section 4943(d)(4), the term ``business enterprise'' does 
not include a trade or business at least 95 percent of the gross income 
of which is derived from passive sources; except that if in the taxable 
year in question less than 95 percent of the income of a trade or 
business is from passive sources, the foundation may, in applying this 
95 percent test, substitute for the passive source gross income in such 
taxable year the average gross income from passive sources for the 10 
taxable years immediately preceding the taxable year in question (or for 
such shorter period as the entity has been in existence). Thus, stock in 
a passive holding company is not to be considered a holding in a 
business enterprise even if the company is controlled by the foundation. 
Instead, the foundation is treated as owning its proportionate share of 
any interests in a business enterprise held by such company under 
section 4943(d)(1).
    (2) Gross income from passive sources. Gross income from passive 
sources, for purposes of this paragraph, includes the items excluded by 
section 512(b)(1) (relating to dividends, interest, and annuities), 
512(b)(2) (relating to royalties), 512(b)(3) (relating to rent) and 
512(b)(5) (relating to gains or losses from the disposition of certain 
property). Any income classified as passive under this paragraph does 
not lose its character merely because section 512(b)(4) or 514 (relating 
to unrelated debt-financed income) applies to such income. In addition, 
income from passive sources includes income from the sale of goods 
(including charges or costs passed on at cost to purchasers of such 
goods or income received in settlement of a dispute concerning or in 
lieu of the exercise of the right to sell such goods) if the seller does 
not manufacture, produce, physically receive or deliver, negotiate sales 
of, or maintain inventories in such goods. Thus, for example, where a 
corporation purchases a product under a contract with the manufacturer, 
resells it under contract at a uniform markup in price, and does not 
physically handle the product, the income derived from that markup meets 
the definition of passive income for purposes of this paragraph. On the 
other hand, income from individually negotiated sales, such as those 
made by a broker, would not meet such definition even if the broker did 
not physically handle the goods.
    (3) Affiliated group. (i) For a common parent corporation in an 
affiliated group, substitute ``consolidated gross income'' in 
subparagraph (1) of this paragraph.
    (ii) For purposes of this section, the term affiliated group shall 
have the same meaning as in section 1504(a), without regard to section 
1504 (b) through (e).
    (iii) Section 53.4943-11(d) provides a transitional rule for certain 
parent corporations.
    (d) Application of section 4943(c)(6)--(1) Program related 
activities. If a private foundation holds an interest which is not an 
interest in a business enterprise because of paragraph (b) of this 
section (relating to program related activities), and such interest 
later becomes an interest in a business enterprise solely by reason of 
failing to meet the requirements of such paragraph (b), such interest 
will then be subject to section (regardless of when it was originally 
acquired) and will be treated as having been acquired other than by 
purchase for purposes of section 4943(c)(6).
    (2) Passive holdings, etc. (i) Except as provided in subdivision 
(ii), if a private

[[Page 160]]

foundation holds an interest that is not an interest in a business 
enterprise, and the interest later becomes an interest in a business 
enterprise (other than by reason of a readjustment as defined in Sec. 
53.4943-7(d)(1)), the interest will be treated as having been acquired 
by purchase by a disqualified person at the time the interest becomes an 
interest in a business enterprise. The treatment of an interest that 
becomes an interest in a business enterprise by reason of a readjustment 
shall be determined under Sec. 53.4943-6 and Sec. 53.4943-7.
    (ii) If a private foundation establishes that the events which 
caused an interest not originally a business enterprise to become a 
business enterprise were not effectively controlled by the private 
foundation, then such interest shall be treated as acquired other than 
by purchase from the time of the change for purposes of section 
4943(c)(6).
    (iii) See Sec. 53.4943-3(b)(3)(ii) for the definition of effective 
control.
    (e) Sole proprietorship. For purposes of section 4943 and the 
regulations thereunder, the term ``sole proprietorship'' means any 
business enterprise (as defined in paragraphs (a), (b), and (c) of this 
section:
    (1) Which is actually and directly owned by a private foundation,
    (2) In which the foundation has a 100 percent equity interest, and
    (3) Which is not held by a corporation, trust, or other business 
entity for such foundation.

A foundation may be considered to own a sole proprietorship even though 
the foundation is itself a corporation or a trust. However, a sole 
proprietorship which is owned by a foundation shall cease to be treated 
as a sole proprietorship when the foundation no longer has a 100-percent 
interest in the equity of the business enterprise. Thus, if and when a 
foundation sells a 10-percent interest in a sole proprietorship, such 
business enterprise shall be treated as a partnership under section 4943 
and the regulations thereunder.

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR 
6484, Feb. 22, 1984]



Sec. 53.4943-11  Effective date.

    (a) In general. Section 4943 and Sec. Sec. 53.4943-1 through 
53.4943-11 shall take effect for taxable years beginning after December 
31, 1969, except as otherwise provided by such sections.
    (b) Special transitional rule. In the case of any acquisition of 
excess holdings prior to February 2, 1973, section 4943(a)(1) shall not 
apply if correction occurs (within the meaning of paragraph (c) of Sec. 
53.4943-9) within a period ending 90 days after July 5, 1977 extended 
(prior to the expiration of the original period) by any period which the 
Commissioner determines is reasonable and necessary (within the meaning 
of paragraph (b) of Sec. 53.4943-9) to bring about such correction.
    (c) Special transitional rule for acquisition by will, etc. (1) The 
rule in Sec. 53.4943-6(b)(1) whereby holdings not held by a decedent 
are not treated as acquired under a will shall not apply to acquisitions 
of after-acquired property of a decedent's estate occurring on or before 
May 22, 1984.
    (2) The rule in Sec. 53.4943-6(b)(1) treating a purchase by an 
estate as a purchase by a disqualified person where the executor is a 
disqualified person shall not apply to purchases occurring on or before 
May 22, 1984.
    (d) Special transitional rule for affiliated groups. If on or before 
May 22, 1984 a foundation holds an interest in a common parent 
corporation in an affiliated group, as defined in Sec. 53.4943-
10(c)(3)(ii), the foundation may elect to have both Sec. 53.4943-
8(c)(4) and Sec. 53.4943-10(c)(3) not apply to such common parent 
corporation. No election may be made to have only one section not apply. 
Such election shall be made by the governing body of the private 
foundation at any time prior to February 22, 1985.
    (e) Special transitional rule for changes to a business enterprise. 
Any interest that is not an interest in a business enterprise which 
becomes an interest in a business enterprise under Sec. 53.4943-
10(d)(2) prior to May 22, 1984 will be treated as having been acquired 
other than by purchase for purposes of section 4943(c)(6).

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR 
6485, Feb. 22, 1984]

[[Page 161]]



   Subpart E_Taxes on Investments Which Jeopardize Charitable Purpose

    Source: T.D. 7240, 37 FR 28747, Dec. 27, 1972, unless otherwise 
noted.



Sec. 53.4944-1  Initial taxes.

    (a) On the private foundation--(1) In general. If a private 
foundation (as defined in section 509) invests any amount in such a 
manner as to jeopardize the carrying out of any of its exempt purposes, 
section 4944(a) (1) of the Code imposes an excise tax on the making of 
such investment. This tax is to be paid by the private foundation and is 
at the rate of 5 percent of the amount so invested for each taxable year 
(or part thereof) in the taxable period (as defined in section 4944(e) 
(1)). The tax imposed by section 4944(a)(1) and this paragraph shall 
apply to investments of either income or principal.
    (2) Jeopardizing investments. (i) Except as provided in section 
4944(c), Sec. 53.4944-3, Sec. 53.4944-6(a), and subdivision (ii) of 
this subparagraph, an investment shall be considered to jeopardize the 
carrying out of the exempt purposes of a private foundation if it is 
determined that the foundation managers, in making such investment, have 
failed to exercise ordinary business care and prudence, under the facts 
and circumstances prevailing at the time of making the investment, in 
providing for the long- and short-term financial needs of the foundation 
to carry out its exempt purposes. In the exercise of the requisite 
standard of care and prudence the foundation managers may take into 
account the expected return (including both income and appreciation of 
capital), the risks of rising and falling price levels, and the need for 
diversification within the investment portfolio (for example, with 
respect to type of security, type of industry, maturity of company, 
degree of risk and potential for return). The determination whether the 
investment of a particular amount jeopardizes the carrying out of the 
exempt purposes of a foundation shall be made on an investment by 
investment basis, in each case taking into account the foundation's 
portfolio as a whole. No category of investments shall be treated as a 
per se violation of section 4944. However, the following are examples of 
types or methods of investment which will be closely scrutinized to 
determine whether the foundation managers have met the requisite 
standard of care and prudence: Trading in securities on margin, trading 
in commodity futures, investments in working interests in oil and gas 
wells, the purchase of ``puts,'' ``calls,'' and ``straddles,'' the 
purchase of warrants, and selling short. The determination whether the 
investment of any amount jeopardizes the carrying out of a foundation's 
exempt purposes is to be made as of the time that the foundation makes 
the investment and not subsequently on the basis of hindsight. 
Therefore, once it has been ascertained that an investment does not 
jeopardize the carrying out of a foundation's exempt purposes, the 
investment shall never be considered to jeopardize the carrying out of 
such purposes, even though, as a result of such investment, the 
foundation subsequently realizes a loss. The provisions of section 4944 
and the regulations thereunder shall not exempt or relieve any person 
from compliance with any Federal or State law imposing any obligation, 
duty, responsibility, or other standard of conduct with respect to the 
operation or administration of an organization or trust to which section 
4944 applies. Nor shall any State law exempt or relieve any person from 
any obligation, duty, responsibility, or other standard of conduct 
provided in section 4944 and the regulations thereunder.
    (ii)(a) Section 4944 shall not apply to an investment made by any 
person which is later gratuitously transferred to a private foundation. 
If such foundation furnishes any consideration to such person upon the 
transfer, the foundation will be treated as having made an investment 
(within the meaning of section 4944(a)(1)) in the amount of such 
consideration.
    (b) Section 4944 shall not apply to an investment which is acquired 
by a private foundation solely as a result of a corporate reorganization 
within the meaning of section 368(a).
    (iii) For purposes of section 4944, a private foundation which, 
after December 31, 1969, changes the form or terms

[[Page 162]]

of an investment (regardless of whether subdivision (ii) of this 
subparagraph applies to such investment), will be considered to have 
entered into a new investment on the date of such change, except as 
provided in subdivision (ii)(b) of this subparagraph. Accordingly, a 
determination, under subdivision (i) of this subparagraph, whether such 
change in the investment jeopardizes the carrying out of the 
foundation's exempt purposes shall be made at such time.
    (iv) It is not intended that the taxes imposed under Chapter 42 be 
exclusive. For example, if a foundation purchases a sole proprietorship 
in a business enterprise within the meaning of section 4943(d)(4), in 
addition to tax under section 4943, the foundation may be liable for tax 
under section 4944 if the investment jeopardizes the carrying out of any 
of its exempt purposes.
    (b) On the management--(1) In general. In any case in which a tax is 
imposed by section 4944(a)(1) and paragraph (a) of this section, section 
4944 (a)(2) of the Code imposes on the participation of any foundation 
manager in the making of the investment, knowing that it is jeopardizing 
the carrying out of any of the foundation's exempt purposes, a tax equal 
to 5 percent of the amount so invested for each taxable year of the 
foundation (or part thereof) in the taxable period (as defined in 
section 4944(e)(1)), subject to the provisions of section 4944(d) and 
Sec. 53.4944-4, unless such participation is not willful and is due to 
reasonable cause. The tax imposed under section 4944(a)(2) shall be paid 
by the foundation manager.
    (2) Definitions and special rules--(i) Knowing. For purposes of 
section 4944, a foundation manager shall be considered to have 
participated in the making of an investment ``knowing'' that it is 
jeopardizing the carrying out of any of the foundation's exempt purposes 
only if:
    (a) He has actual knowledge of sufficient facts so that, based 
solely upon such facts, such investment would be a jeopardizing 
investment under paragraph (a)(2) of this section,
    (b) He is aware that such an investment under these circumstances 
may violate the provisions of federal tax law governing jeopardizing 
investments, and
    (c) He negligently fails to make reasonable attempts to ascertain 
whether the investment is a jeopardizing investment, or he is in fact 
aware that it is such an investment.

For purposes of this part and Chapter 42, the term knowing does not mean 
``having reason to know''. However, evidence tending to show that a 
foundation manager has reason to know of a particular fact or particular 
rule is relevant in determining whether he had actual knowledge of such 
fact or rule. Thus, for example, evidence tending to show that a 
foundation manager has reason to know of sufficient facts so that, based 
solely upon such facts, an investment would be a jeopardizing investment 
is relevant in determining whether he has actual knowledge of such 
facts.
    (ii) Willful. A foundation manager's participation in a jeopardizing 
investment is willful if it is voluntary, conscious, and intentional. No 
motive to avoid the restrictions of the law or the incurrence of any tax 
is necessary to make such participation willfull. However, a foundation 
manager's participation in a jeopardizing investment is not willful if 
he does not know that it is a jeopardizing investment under paragraph 
(a)(2) of this section.
    (iii) Due to reasonable cause. A foundation manager's actions are 
due to reasonable cause if he has exercised his responsibility on behalf 
of the foundation with ordinary business care and prudence.
    (iv) Participation. The participation of any foundation manager in 
the making of an investment shall consist of any manifestation of 
approval of the investment.
    (v) Advice of counsel. If a foundation manager, after full 
disclosure of the factual situation to legal counsel (including house 
counsel), relies on the advice of such counsel expressed in a reasoned 
written legal opinion that a particular investment would not jeopardize 
the carrying out of any of the foundation's exempt purposes (because, as 
a matter of law, the investment is excepted from such classification, 
for

[[Page 163]]

example, as a program-related investment under section 4944(c)), then 
although such investment is subsequently held to be a jeopardizing 
investment under paragraph (a)(2) of this section, the foundation 
manager's participation in such investment will ordinarily not be 
considered ``knowing'' or ``willfull'' and will ordinarily be considered 
``due to reasonable cause'' within the meaning of section 4944(a) (2). 
In addition, if a foundation manager, after full disclosure of the 
factual situation to qualified investment counsel, relies on the advice 
of such counsel, such advice being derived in a manner consistent with 
generally accepted practices of persons who are such a qualified 
investment counsel and being expressed in writing that a particular 
investment will provide for the long and short term financial needs of 
the foundation under paragraph (a)(2) of this section, then although 
such investment is subsequently held not to provide for such long and 
short term financial needs, the foundation manager's participation in 
failing to provide for such long and short term financial needs will 
ordinarily not be considered ``knowing'' or ``willful'' and will 
ordinarily be considered ``due to reasonable cause'' within the meaning 
of section 4944(a)(2). For purposes of this subdivision, a written legal 
opinion will be considered ``reasoned'' even if it reaches a conclusion 
which is subsequently determined to be incorrect so long as such opinion 
addresses itself to the facts and applicable law. However, a written 
legal opinion will not be considered ``reasoned'' if it does nothing 
more than recite the facts and express a conclusion. However, the 
absence of advice of legal counsel or qualified investment counsel with 
respect to the investment shall not, by itself, give rise to any 
inference that a foundation manager participated in such investment 
knowingly, willfully, or without reasonable cause.
    (vi) Cross reference. For provisions relating to the burden of proof 
in cases involving the issue whether a foundation manager has knowingly 
participated in the making of a jeopardizing investment, see section 
7454(b).
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. A is a foundation manager of B, a private foundation with 
assets of $100,000. A approves the following three investments by B 
after taking into account with respect to each of them B's portfolio as 
a whole: (1) An investment of $5,000 in the common stock of corporation 
X; (2) an investment of $10,000 in the common stock of corporation Y; 
and (3) an investment of $8,000 in the common stock of corporation Z. 
Corporation X has been in business a considerable time, its record of 
earnings is good and there is no reason to anticipate a diminution of 
its earnings. Corporation Y has a promising product, has had earnings in 
some years and substantial losses in others, has never paid a dividend, 
and is widely reported in investment advisory services as seriously 
undercapitalized. Corporation Z has been in business a short period of 
time and manufactures a product that is new, is not sold by others, and 
must compete with a well-established alternative product that serves the 
same purpose. Z's stock is classified as a high-risk investment by most 
investment advisory services with the possibility of substantial long-
term appreciation but with little prospect of a current return. A has 
studied the records of the three corporations and knows the foregoing 
facts. In each case the price per share of common stock purchased by B 
is favorable to B. Under the standards of paragraph (a)(2)(i) of this 
section, the investment of $10,000 in the common stock of Y and the 
investment of $8,000 in the common stock of Z may be classified as 
jeopardizing investments, while the investment of $5,000 in the common 
stock of X will not be so classified. B would then be liable for an 
initial tax of $500 (i.e., 5 percent of $10,000) for each year (or part 
thereof) in the taxable period for the investment in Y, and an initial 
tax of $400 (i.e., 5 percent of $8,000) for each year (or part thereof) 
in the taxable period for the investment in Z. Further, since A had 
actual knowledge that the investments in the common stock of Y and Z 
were jeopardizing investments, A would then be liable for the same 
amount of initial taxes as B.
    Example 2. Assume the facts as stated in Example (1), except that: 
(1) In the case of corporation Y, B's investment will be made for new 
stock to be issued by Y and there is reason to anticipate that B's 
investment, together with investments required by B to be made 
concurrently with its own, will satisfy the capital needs of corporation 
Y and will thereby overcome the difficulties that have resulted in Y's 
uneven earnings record; and (2) in the case of corporation Z, the 
management has a demonstrated capacity for getting new businesses 
started successfully and Z has received substantial orders for its new

[[Page 164]]

product. Under the standards of paragraph (a) (2) (i) of this section, 
neither the investment in Y nor the investment in Z will be classified 
as a jeopardizing investment and neither A nor B will be liable for an 
initial tax on either of such investments.
    Example 3. D is a foundation manager of E, a private foundation with 
assets of $200,000. D was hired by E to manage E's investments after a 
careful review of D's training, experience and record in the field of 
investment management and advice indicated to E that D was well 
qualified to provide professional investment advice in the management of 
E's investment assets. D, after careful research into how best to 
diversify E's investments, provide for E's long-term financial needs, 
and protect against the effects of long-term inflation, decides to 
allocate a portion of E's investment assets to unimproved real estate in 
selected areas of the country where population patterns and economic 
factors strongly indicate continuing growth at a rapid rate. D 
determines that the short-term financial needs of E can be met through 
E's other investments. Under the standards of paragraph (a)(2)(i) of 
this section, the investment of a portion of E's investment assets in 
unimproved real estate will not be classified as a jeopardizing 
investment and neither D nor E will be liable for an initial tax on such 
investment.

[T.D. 7240, 37 FR 28747, Dec. 29, 1972, as amended by T.D. 7299, 38 FR 
35304, Dec. 27, 1973]



Sec. 53.4944-2  Additional taxes.

    (a) On the private foundation. Section 4944(b)(1) of the Code 
imposes an excise tax in any case in which an initial tax is imposed by 
section 4944(a)(1) and Sec. 53.4944-1(a) on the making of a 
jeopardizing investment by a private foundation and such investment is 
not removed from jeopardy within the taxable period (as defined in 
section 4944(e)(1)). The tax imposed under section 4944(b)(1) is to be 
paid by the private foundation and is at the rate of 25 percent of the 
amount of the investment. This tax shall be imposed upon the portion of 
the investment which has not been removed from jeopardy within the 
taxable period.
    (b) On the management. Section 4944(b)(2) of the Code imposes an 
excise tax in any case in which an additional tax is imposed by section 
4944 (b)(1) and paragraph (a) of this section and a foundation manager 
has refused to agree to part or all of the removal of the investment 
from jeopardy. The tax imposed under section 4944(b)(2) is at the rate 
of 5 percent of the amount of the investment, subject to the provisions 
of section 4944(d) and Sec. 53.4944-4. This tax is to be paid by any 
foundation manager who has refused to agree to the removal of part or 
all of the investment from jeopardy, and shall be imposed upon the 
portion of the investment which has not been removed from jeopardy 
within the taxable period.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X is a foundation manager of Y, a private foundation. On 
the advice of X, Y invests $5,000 in the common stock of corporation M. 
Assume that both X and Y are liable for the taxes imposed by section 
4944(a) on the making of the investment. Assume further that no part of 
the investment is removed from jeopardy within the taxable period and 
that X refused to agree to such removal. Y will be liable for an 
additional tax of $1,250 (i.e., $5,000x25%). X will be liable for an 
additional tax of $250 (i.e., $5,000x5%).
    Example 2. Assume the facts as stated in Example (1), except that X 
is not liable for the tax imposed by section 4944(a)(2) for his 
participation in the making of the investment, because such 
participation was not willful and was due to reasonable cause. X will 
nonetheless be liable for the tax of $250 imposed by section 4944(b)(2) 
since an additional tax has been imposed upon Y and since X refused to 
agree to the removal of the investment from jeopardy.
    Example 3. Assume the facts as stated in Example (1), except that Y 
removes $2,000 of the investment from jeopardy within the taxable 
period, with X refusing to agree to the removal from jeopardy of the 
remaining $3,000 of such investment. Y will be liable for an additional 
tax of $750, imposed upon the portion of the investment which has not 
been removed from jeopardy within the taxable period (i.e., $3,000x25%). 
Further X will be liable for an additional tax of $150, also imposed 
upon the same portion of the investment (i.e., $3,000x5%).

[T.D. 7240, 37 FR 28747, Dec. 27, 1972, as amended by T.D. 8084, 51 FR 
16302, May 2, 1986]



Sec. 53.4944-3  Exception for program-related investments.

    (a) In general. (1) For purposes of section 4944 and Sec. Sec. 
53.4944-1 through 53.4944-6, a ``program-related investment'' shall not 
be classified as an investment which jeopardizes the carrying out of the 
exempt purposes of a private foundation. A program-related

[[Page 165]]

investment is an investment which possesses the following 
characteristics:
    (i) The primary purpose of the investment is to accomplish one or 
more of the purposes described in section 170(c)(2)(B);
    (ii) No significant purpose of the investment is the production of 
income or the appreciation of property; and
    (iii) No purpose of the investment is to accomplish one or more of 
the purposes described in section 170(c)(2)(D).
    (2)(i) An investment shall be considered as made primarily to 
accomplish one or more of the purposes described in section 170(c)(2)(B) 
if it significantly furthers the accomplishment of the private 
foundation's exempt activities and if the investment would not have been 
made but for such relationship between the investment and the 
accomplishment of the foundation's exempt activities. For purposes of 
section 4944 and Sec. Sec. 53.4944-1 through 53.4944-6, the term 
purposes described in section 170(c)(2)(B) shall be treated as including 
purposes described in section 170(c)(2)(B) whether or not carried out by 
organizations described in section 170(c).
    (ii) An investment in an activity described in section 4942(j)(5)(B) 
and the regulations thereunder shall be considered, for purposes of this 
paragraph, as made primarily to accomplish one or more of the purposes 
described in section 170(c)(2)(B).
    (iii) In determining whether a significant purpose of an investment 
is the production of income or the appreciation of property, it shall be 
relevant whether investors solely engaged in the investment for profit 
would be likely to make the investment on the same terms as the private 
foundation. However, the fact that an investment produces significant 
income or capital appreciation shall not, in the absence of other 
factors, be conclusive evidence of a significant purpose involving the 
production of income or the appreciation of property.
    (iv) An investment shall not be considered as made to accomplish one 
or more of the purposes described in section 170(c)(2)(D) if the 
recipient of the investment appears before, or communicates to, any 
legislative body with respect to legislation or proposed legislation of 
direct interest to such recipient, provided that the expense of engaging 
in such activities would qualify as a deduction under section 162.
    (3)(i) Once it has been determined that an investment is ``program-
related'' it shall not cease to qualify as a ``program-related 
investment'' provided that changes, if any, in the form or terms of the 
investment are made primarily for exempt purposes and not for any 
significant purpose involving the production of income or the 
appreciation of property. A change made in the form or terms of a 
program-related investment for the prudent protection of the 
foundation's investment shall not ordinarily cause the investment to 
cease to qualify as program-related. Under certain conditions, a 
program-related investment may cease to be program-related because of a 
critical change in circumstances, as, for example, where it is serving 
an illegal purpose or the private purpose of the foundation or its 
managers. For purposes of the preceding sentence, an investment which 
ceases to be program-related because of a critical change in 
circumstances shall in no event subject the foundation making the 
investment to the tax imposed by section 4944(a)(1) before the 30th day 
after the date on which such foundation (or any of its managers) has 
actual knowledge of such critical change in circumstances.
    (ii) If a private foundation changes the form or terms of an 
investment, and if, as a result of the application of subdivision (i) of 
this subparagraph, such investment no longer qualifies as program-
related, the determination whether the investment jeopardizes the 
carrying out of exempt purposes shall be made pursuant to the provisions 
of Sec. 53.4944-1(a)(2).
    (b) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X is a small business enterprise located in a 
deteriorated urban area and owned by members of an economically 
disadvantaged minority group. Conventional sources of funds are 
unwilling or unable to provide funds to X on terms it considers 
economically feasible. Y, a private foundation, makes a loan to X 
bearing interest below the market rate for commercial loans of 
comparable risk. Y's primary purpose for making

[[Page 166]]

the loan is to encourage the economic development of such minority 
groups. The loan has no significant purpose involving the production of 
income or the appreciation of property. The loan significantly furthers 
the accomplishment of Y's exempt activities and would not have been made 
but for such relationship between the loan and Y's exempt activities. 
Accordingly, the loan is a program-related investment even though Y may 
earn income from the investment in an amount comparable to or higher 
than earnings from conventional portfolio investments.
    Example 2. Assume the facts as stated in Example (1), except that 
after the date of execution of the loan Y extends the due date of the 
loan. The extension is granted in order to permit X to achieve greater 
financial stability before it is required to repay the loan. Since the 
change in the terms of the loan is made primarily for exempt purposes 
and not for any significant purpose involving the production of income 
or the appreciation of property, the loan shall continue to qualify as a 
program-related investment.
    Example 3. X is a small business enterprise located in a 
deteriorated urban area and owned by members of an economically 
disadvantaged minority group. Conventional sources of funds are 
unwilling to provide funds to X at reasonable interest rates unless it 
increases the amount of its equity capital. Consequently, Y, a private 
foundation, purchases shares of X's common stock. Y's primary purpose in 
purchasing the stock is to encourage the economic development of such 
minority group, and no significant purpose involves the production of 
income or the appreciation of property. The investment significantly 
furthers the accomplishment of Y's exempt activities and would not have 
been made but for such relationship between the investment and Y's 
exempt activities. Accordingly, the purchase of the common stock is a 
program-related investment, even though Y may realize a profit if X is 
successful and the common stock appreciates in value.
    Example 4. X is a business enterprise which is not owned by low-
income persons or minority group members, but the continued operation of 
X is important to the economic well-being of a deteriorated urban area 
because X employes a substantial number of low-income persons from such 
area. Conventional sources of funds are unwilling or unable to provide 
funds to X at reasonable interest rates. Y, a private foundation, makes 
a loan to X at an interest rate below the market rate for commercial 
loans of comparable risk. The loan is made pursuant to a program run by 
Y to assist low-income persons by providing increased economic 
opportunities and to prevent community deterioration. No significant 
purpose of the loan involves the production of income or the 
appreciation of property. The investment significantly furthers the 
accomplishment of Y's exempt activities and would not have been made but 
for such relationship between the loan and Y's exempt activities. 
Accordingly, the loan is a program-related investment.
    Example 5. X is a business enterprise which is financially secure 
and the stock of which is listed and traded on a national exchange. Y, a 
private foundation, makes a loan to X at an interest rate below the 
market rate in order to induce X to establish a new plant in a 
deteriorated urban area which, because of the high risks involved, X 
would be unwilling to establish absent such inducement. The loan is made 
pursuant to a program run by Y to enhance the economic development of 
the area by, for example, providing employment opportunities for low-
income persons at the new plant, and no significant purpose involves the 
production of income or the appreciation of property. The loan 
significantly furthers the accomplishment of Y's exempt activities and 
would not have been made but for such relationship between the loan and 
Y's exempt activities. Accordingly, even though X is large and 
established, the investment is program-related.
    Example 6. X is a business enterprise which is owned by a nonprofit 
community development corporation. When fully operational, X will market 
agricultural products, thereby providing a marketing outlet for low-
income farmers in a depressed rural area. Y, a private foundation, makes 
a loan to X bearing interest at a rate less than the rate charged by 
financial institutions which have agreed to lend funds to X if Y makes 
the loan. The loan is made pursuant to a program run by Y to encourage 
economic redevelopment of depressed areas, and no significant purpose 
involves the production of income or the appreciation of property. The 
loan significantly furthers the accomplishment of Y's exempt activities 
and would not have been made but for such relationship between the loan 
and Y's exempt activities. Accordingly, the loan is a program-related 
investment.
    Example 7. X, a private foundation, invests $100,000 in the common 
stock of corporation M. The dividends received from such investment are 
later applied by X in furtherance of its exempt purposes. Although there 
is a relationship between the return on the investment and the 
accomplishment of X's exempt activities, there is no relationship 
between the investment per se and such accomplishment. Therefore, the 
investment cannot be considered as made primarily to accomplish one or 
more of the purposes described in section 170(c)(2)(B) and cannot 
qualify as program-related.
    Example 8. S, a private foundation, makes an investment in T, a 
business corporation, which qualifies as a program-related investment 
under section 4944(c) at the time that it is made. All of T's voting 
stock is owned

[[Page 167]]

by S. T experiences financial and management problems which, in the 
judgment of the foundation, require changes in management, in financial 
structure or in the form of the investment. The following three methods 
of resolving the problems appear feasible to S, but each of the three 
methods would result in reduction of the exempt purposes for which the 
program-related investment was initially made:
    (a) Sale of stock or assets. The foundation sells its stock to an 
unrelated person. Payment is made in part at the time of sale; the 
balance is payable over an extended term of years with interest on the 
amount outstanding. The foundation receives a purchase-money mortgage.
    (b) Lease. The corporation leases its assets for a term of years to 
an unrelated person, with an option in the lessee to buy the assets. If 
the option is exercised, the terms of payment are to be similar to those 
described in (a) of this example.
    (c) Management contract. The corporation enters into a management 
contract which gives broad operating authority to one or more unrelated 
persons for a term of years. The foundation and the unrelated persons 
are obligated to contribute toward working capital requirements. The 
unrelated persons will be compensated by a fixed fee or a share of 
profits, and they will receive an option to buy the stock held by S or 
the assets of the corporation. If the option is exercised, the terms of 
payment are to be similar to those described in (a) of this example.


Each of the three methods involves a change in the form or terms of a 
program-related investment for the prudent protection of the 
foundation's investment. Thus, under Sec. 53.4944-3(a)(3)(i), none of 
the three transactions (nor any debt instruments or other obligations 
held by S as a result of engaging in one of these transactions) would 
cause the investment to cease to qualify as program-related.
    Example 9. X is a socially and economically disadvantaged 
individual. Y, a private foundation, makes an interest-free loan to X 
for the primary purpose of enabling X to attend college. The loan has no 
significant purpose involving the production of income or the 
appreciation of property. The loan significantly furthers the 
accomplishment of Y's exempt activities and would not have been made but 
for such relationship between the loan and Y's exempt activities. 
Accordingly, the loan is a program-related investment.
    Example 10. Y, a private foundation, makes a high-risk investment in 
low-income housing, the indebtedness with respect to which is insured by 
the Federal Housing Administration. Y's primary purpose in making the 
investment is to finance the purchase, rehabilitation, and construction 
of housing for low-income persons. The investment has no significant 
purpose involving the production of income or the appreciation of 
property. The investment significantly furthers the accomplishment of 
Y's exempt activities and would not have been made but for such 
relationship between the investment and Y's exempt activities. 
Accordingly, the investment is program-related.



Sec. 53.4944-4  Special rules.

    (a) Joint and several liability. In any case where more than one 
foundation manager is liable for the tax imposed under section 4944 
(a)(2) or (b)(2) with respect to any one jeopardizing investment, all 
such foundation managers shall be jointly and severally liable for the 
tax imposed under each such paragraph with respect to such investment.
    (b) Limits on liability for management. With respect to anyone 
jeopardizing investment, the maximum aggregate amount of tax collectible 
under section 4944(a)(2) from all foundation managers shall not exceed 
$5,000, and the maximum aggregate amount of tax collectible under 
section 4944(b)(2) from all foundation managers shall not exceed 
$10,000.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. A, B, and C are foundation managers of X, a private 
foundation. Assume that A, B, and C are liable for both initial and 
additional taxes under sections 4944(a)(2) and 4944(b)(2), respectively, 
for the following investments by X: an investment of $5,000 in the 
common stock of corporation M, and an investment of $10,000 in the 
common stock of corporation N. A, B, and C will be jointly and severally 
liable for the following initial taxes under section 4944(a)(2): a tax 
of $250 (i.e., 5 percent of $5,000) for each year (or part thereof) in 
the taxable period (as defined in section 4944(e)(1)) for the investment 
in M, and a tax of $500 (i.e., 5 percent of $10,000) for each year (or 
part thereof) in the taxable period for the investment in N. Further, A, 
B, and C will be jointly and severally liable for the following 
additional taxes under section 4944(b)(2): a tax of $250 (i.e., 5 
percent of $5,000) for the investment in M, and a tax of $500 (i.e., 5 
percent of $10,000) for the investment in N.
    Example 2. Assume the facts as stated in Example (1), except that X 
has invested $500,000 in the common stock of M, and $1 million in the 
common stock of N. A, B, and C will be jointly and severally liable for 
the following initial taxes under section 4944(a)(2): a tax of $5,000 
for the investment in M, and a tax of $5,000 for the investment

[[Page 168]]

in N. Further, A, B, and C will be jointly and severally liable for the 
following additional taxes under section 4944(b) (2): a tax of $10,000 
for the investment in M, and a tax of $10,000 for the investment in N.



Sec. 53.4944-5  Definitions.

    (a) Taxable period--(1) In general. For purposes of section 4944, 
the term ``taxable period'' means, with respect to any investment which 
jeopardizes the carrying out of a private foundation's exempt purposes, 
the period beginning with the date on which the amount is invested and 
ending on the earliest of:
    (i) The date of mailing of a notice of deficiency under section 6212 
with respect to the tax imposed on the making of the investment by 
section 4944(a)(1);
    (ii) The date on which the amount invested is removed from jeopardy; 
or
    (iii) The date on which the tax imposed by section 4944(a)(1) is 
assessed.
    (2) Special rule. Where a notice of deficiency referred to in 
subparagraph (1) (i) of this paragraph is not mailed because there is a 
waiver of the restrictions on assessment and collection of a deficiency, 
or because the deficiency is paid, the date of filing of the waiver or 
the date of such payment, respectively, shall be treated as the end of 
the taxable period.
    (b) Removal from jeopardy. An investment which jeopardizes the 
carrying out of a private foundation's exempt purposes shall be 
considered to be removed from jeopardy when:
    (1) The foundation sells or otherwise disposes of the investment, 
and
    (2) The proceeds of such sale or other disposition are not 
themselves investments which jeopardize the carrying out of such 
foundation's exempt purposes.

A change by a private foundation in the form or terms of a jeopardizing 
investment shall result in the removal of the investment from jeopardy 
if, after such change, the investment no longer jeopardizes the carrying 
out of such foundation's exempt purposes. For purposes of section 4944, 
the making by a private foundation of one jeopardizing investment and a 
subsequent exchange by the foundation of such investment for another 
jeopardizing investment will be treated as only one jeopardizing 
investment, except as provided in Sec. 53.4944-6 (b) and (c). For the 
treatment of a jeopardizing investment which is removed from jeopardy or 
otherwise transferred by a private foundation by the making of a grant 
or by bargain-sale, see sections 4941 and 4945 and the regulations 
thereunder. A jeopardizing investment cannot be removed from jeopardy by 
a transfer from a private foundation to another private foundation which 
is related to the transferor foundation within the meaning of section 
4946(a) (1)(H) (i) or (ii), unless the investment is a program-related 
investment in the hands of the transferee foundation.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X, a private foundation on the calendar year basis, makes 
a $1,000 jeopardizing investment on January 1, 1970. X thereafter sells 
the investment for $1,000 on January 3, 1971. The taxable period is from 
January 1, 1970, to January 3, 1971. X will be liable for an initial tax 
of $100, that is, a tax of 5 percent of the amount of the investment for 
each year (or part thereof) in the taxable period.
    Example 2. Assume that both C and D are investments which jeopardize 
exempt purposes. X, a private foundation, purchases C in 1971 and later 
exchanges C for D. Such exchange does not constitute a removal of C from 
jeopardy. In addition, no new taxable period will arise with respect to 
D, since, for purposes of section 4944, only one jeopardizing investment 
has been made.
    Example 3. Assume the facts as stated in Example (2), except that X 
sells C for cash and later reinvests such cash in D. Two separate 
investments jeopardizing exempt purposes have resulted. Since the cash 
received in the interim is not of a jeopardizing nature, the amount 
invested in C has been removed from jeopardy and, thus, the taxable 
period with respect to C has been terminated. The subsequent 
reinvestment of such cash in D gives rise to a new taxable period with 
respect to D.

    (d) Cross reference. For rules relating to taxable events that are 
corrected within the correction period, defined in section 4963(e), see 
section 4961(a) and the regulations thereunder.

[T.D. 7240, 37 FR 28747, Dec. 27, 1972, as amended by T.D. 8084, 51 FR 
16303, May 2, 1986]

[[Page 169]]



Sec. 53.4944-6  Special rules for investments made prior to 
January 1, 1970.

    (a) Except as provided in paragraph (b) or (c) of this section, an 
investment made by a private foundation prior to January 1, 1970, shall 
not be subject to the provisions of section 4944.
    (b) If the form or terms of an investment made by a private 
foundation prior to January 1, 1970, are changed (other than as 
described in paragraph (c) of this section) on or after such date, the 
provisions of Sec. 53.4944-1(a)(2)(iii) shall apply with respect to 
such investment.
    (c) In the case of an investment made by a private foundation prior 
to January 1, 1970, which is exchanged on or after such date for another 
investment, for purposes of section 4944 the foundation will be 
considered to have made a new investment on the date of such exchange, 
unless the post-1969 investment is described in Sec. 53.4944-
1(a)(2)(ii)(b). Accordingly, a determination, under Sec. 53.4944-1(a) 
(2)(i), whether the investment jeopardizes the carrying out of the 
foundation's exempt purposes shall be made at such time.



                 Subpart F_Taxes on Taxable Expenditures

    Source: T.D. 7215, 37 FR 23161, Oct. 31, 1972, unless otherwise 
noted.



Sec. 53.4945-1  Taxes on taxable expenditures.

    (a) Imposition of initial taxes--(1) Tax on private foundation. 
Section 4945(a)(1) of the Code imposes an excise tax on each taxable 
expenditure (as defined in section 4945(d)) of a private foundation. 
This tax is to be paid by the private foundation and is at the rate of 
10 percent of the amount of each taxable expenditure.
    (2) Tax on foundation manager--(i) In general. Section 4945(a)(2) of 
the Code imposes, under certain circumstances, an excise tax on the 
agreement of any foundation manager to the making of a taxable 
expenditure by a private foundation. This tax is imposed only in cases 
in which the following circumstances are present:
    (a) A tax is imposed by section 4945(a)(1);
    (b) Such foundation manager knows that the expenditure to which he 
agrees is a taxable expenditure, and
    (c) Such agreement is willfull and is not due to reasonable cause.


However, the tax with respect to any particular expenditure applies only 
to the agreement of those foundation managers who are authorized to 
approve, or to exercise discretion in recommending approval of, the 
making of the expenditure by the foundation and to those foundation 
managers who are members of a group (such as the foundation's board of 
directors or trustees) which is so authorized. For the definition of the 
term foundation manager, see section 4946(b) and the regulations 
thereunder.
    (ii) Agreement. The agreement of any foundation manager to the 
making of a taxable expenditure shall consist of any manifestation of 
approval of the expenditure which is sufficient to constitute an 
exercise of the foundation manager's authority to approve, or to 
exercise discretion in recommending approval of, the making of the 
expenditure by the foundation, whether or not such manifestation of 
approval is the final or decisive approval on behalf of the foundation.
    (iii) Knowing. For purposes of section 4945, a foundation mangager 
shall be considered to have agreed to an expenditure ``knowing'' that it 
is a taxable expenditure only if:
    (a) He has actual knowledge of sufficient facts so that, based 
solely upon such facts, such expenditure would be a taxable expenditure,
    (b) He is aware that such an expenditure under these circumstances 
may violate the provisions of federal tax law governing taxable 
expenditures, and
    (c) He negligently fails to make reasonable attempts to ascertain 
whether the expenditure is a taxable expenditure, or he is in fact aware 
that it is such an expenditure.


For purposes of this part and Chapter 42, the term knowing does not mean 
``having reason to know''. However, evidence tending to show that a 
foundation manager has reason to know of a particular fact or particular 
rule is relevant in determining whether he

[[Page 170]]

had actual knowledge of such fact or rule. Thus, for example, evidence 
tending to show that a foundation manager has reason to know of 
sufficient facts so that, based solely upon such facts, an expenditure 
would be a taxable expenditure is relevant in determining whether he has 
actual knowledge of such facts.
    (iv) Willful. A foundation manager's agreement to a taxable 
expenditure is willful if it is voluntary, conscious, and intentional. 
No motive to avoid the restrictions of the law or the incurrence of any 
tax is necessary to make an agreement willful. However, a foundation 
manager's agreement to a taxable expenditure is not willful if he does 
not know that it is a taxable expenditure.
    (v) Due to reasonable cause. A foundation manager's actions are due 
to reasonable cause if he has exercised his responsibility on behalf of 
the foundation with ordinary business care and prudence.
    (vi) Advice of counsel. If a foundation manager, after full 
disclosure of the factual situation to legal counsel (including house 
counsel), relies on the advice of such counsel expressed in a reasoned 
written legal opinion that an expenditure is not a taxable expenditure 
under section 4945 (or that expenditures conforming to certain 
guidelines are not taxable expenditures), although such expenditure is 
subsequently held to be a taxable expenditure (or that certain proposed 
reporting procedures with respect to an expenditure will satisfy the 
tests of section 4945(h), although such procedures are subsequently held 
not to satisfy such section), the foundation manager's agreement to such 
expenditure (or to grants made with provision for such reporting 
procedures which are taxable solely because of such inadequate reporting 
procedures) will ordinarily not be considered ``knowing'' or ``willful'' 
and will ordinarily be considered ``due to reasonable cause'' within the 
meaning of section 4945(a)(2). For purposes of the subdivision, a 
written legal opinion will be considered ``reasoned'' even if it reaches 
a conclusion which is subsequently determined to be incorrect so long as 
such opinion addresses itself to the facts and applicable law. However, 
a written legal opinion will not be considered ``reasoned'' if it does 
nothing more than recite the facts and express a conclusion. However, 
the absence of advice of counsel with respect to an expenditure shall 
not, by itself, give rise to any inference that a foundation manager 
agreed to the making of the expenditure knowingly, willfully, or without 
reasonable cause.
    (vii) Rate and incidence of tax. The tax imposed under section 
4945(a)(2) is at the rate of 2\1/2\ percent of the amount of each 
taxable expenditure to which the foundation manager has agreed. This tax 
shall be paid by the foundation manager.
    (viii) Cross reference. For provisions relating to the burden of 
proof in cases involving the issue whether a foundation manager has 
knowingly agreed to the making of a taxable expenditure, see section 
7454(b).
    (b) Imposition of additional taxes--(1) Tax on private foundation. 
Section 4945(b)(1) of the Code imposes an excise tax in any case in 
which an initial tax is imposed under section 4945(a)(1) on a taxable 
expenditure of a private foundation and the expenditure is not corrected 
within the taxable period (as defined in section 4945(i)(2)). The tax 
imposed under section 4945(b)(1) is to be paid by the private foundation 
and is at the rate of 100 percent of the amount of each taxable 
expenditure.
    (2) Tax on foundation manager. Section 4945(b)(2) of the Code 
imposes an excise tax in any case in which a tax is imposed under 
section 4945(b)(1) and a foundation manager has refused to agree to part 
or all of the correction of the taxable expenditure. The tax imposed 
under section 4945(b)(2) is at the rate of 50 percent of the amount of 
the taxable expenditure. This tax is to be paid by any foundation 
manager who has refused to agree to part or all of the correction of the 
taxable expenditure.
    (c) Special rules--(1) Joint and several liability. In any case 
where more than one foundation manager is liable for tax imposed under 
section 4945 (a) (2) or (b)(2) with respect to the making of a taxable 
expenditure, all such foundation managers shall be jointly and severally 
liable for the tax imposed under such paragraph with respect to such 
taxable expenditure.

[[Page 171]]

    (2) Limits on liability for management. The maximum aggregate amount 
of tax collectible under section 4945(a)(2) from all foundation managers 
with respect to any one taxable expenditure shall be $5,000, and the 
maximum aggregate amount of tax collectible under section 4945(b) (2) 
from all foundation managers with respect to any one taxable expenditure 
shall be $10,000.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. A, B, and C comprise the board of directors of Foundation 
M. They vote unanimously in favor of a grant of $100,000 to D, a 
business associate of each of the directors. The grant is to be used by 
D for travel and educational purposes and is not made in accordance with 
the requirements of section 4945(g). Each director knows that D was 
selected as the recipient of the grant solely because of his friendship 
with the directors and is aware that some grants made for travel, study, 
or other similar purposes may be taxable expenditures. Also, none of the 
directors makes any attempt to consult counsel, or to otherwise 
determine, whether this grant is a taxable expenditure. Initial taxes 
are imposed under paragraphs (1) and (2) of section 4945(a). The tax to 
be paid by the foundation is $10,000 (10 percent of $100,000). The tax 
to be paid by the board of directors is $2,500 (2\1/2\ percent of 
$100,000). A, B, and C are jointly and severally liable for this $2,500 
and this sum may be collected by the Service from any one of them.
    Example 2. Assume the same facts as in example (1). Further assume 
that within the taxable period A makes a motion to correct the taxable 
expenditure at a meeting of the board of directors. The motion is 
defeated by a two-to-one vote, A voting for the motion and B and C 
voting against it. In these circumstances an additional tax is imposed 
on the private foundation in the amount of $100,000 (100 percent of 
$100,000). The additional tax imposed on B and C is $10,000 (50 percent 
of $100,000 subject to a maximum of $10,000). B and C are jointly and 
severally liable for the $10,000, and this sum may be collected by the 
Service from either of them.

    (d) Correction--(1) In general. Except as provided in paragraph (d) 
(2) or (3) of this paragraph, correction of a taxable expenditure shall 
be accomplished by recovering part or all of the expenditure to the 
extent recovery is possible, and, where full recovery cannot be 
accomplished, by any additional corrective action which the Commissioner 
may prescribe. Such additional corrective action is to be determined by 
the circumstances of each particular case and may include the following:
    (i) Requiring that any unpaid funds due the grantee be withheld;
    (ii) Requiring that no further grants be made to the particular 
grantee;
    (iii) In addition to other reports that are required, requiring 
periodic (e.g., quarterly) reports from the foundation with respect to 
all expenditures of the foundation (such reports shall be equivalent in 
detail to the reports required by section 4945(h)(3) and Sec. 53.4945-
5(d));
    (iv) Requiring improved methods of exercising expenditure 
responsibility;
    (v) Requiring improved methods of selecting recipients of individual 
grants; and
    (vi) Requiring such other measures as the Commissioner may prescribe 
in a particular case.

The foundation making the expenditure shall not be under any obligation 
to attempt to recover the expenditure by legal action if such action 
would in all probability not result in the satisfaction of execution on 
a judgment.
    (2) Correction for inadequate reporting. If the expenditure is 
taxable only because of a failure to obtain a full and complete report 
as required by section 4945(h)(2) or because of a failure to make a full 
and detailed report as required by section 4945(h)(3), correction may be 
accomplished by obtaining or making the report in question. In addition, 
if the expenditure is taxable only because of a failure to obtain a full 
and complete report as required by section 4945(h)(2) and an 
investigation indicates that no grant funds have been diverted to any 
use not in furtherance of a purpose specified in the grant, correction 
may be accomplished by exerting all reasonable efforts to obtain the 
report in question and reporting the failure to the Internal Revenue 
Service, even though the report is not finally obtained.
    (3) Correction for failure to obtain advance approval. Where an 
expenditure is taxable under section 4945(d)(3) only because of a 
failure to obtain advance approval of procedures with respect to grants 
as required by section 4945(g), correction may be accomplished by 
obtaining approval of the grant making procedures and establishing to 
the satisfaction of the Commissioner that:

[[Page 172]]

    (i) No grant funds have been diverted to any use not in furtherance 
of a purpose specified in the grant;
    (ii) The grant making procedures instituted would have been approved 
if advance approval of such procedures had been properly requested; and
    (iii) Where advance approval of grant making procedures is 
subsequently required, such approval will be properly requested.
    (e) Certain periods--(1) Taxable period. For purposes of section 
4945, the term ``taxable period'' means, with respect to any taxable 
expenditure, the period beginning with the date on which the taxable 
expenditure occurs and ending on the earlier of:
    (i) The date of mailing of a notice of deficiency under section 6212 
with respect to the tax imposed on taxable expenditures by section 
4945(a)(1); or
    (ii) The date on which the tax imposed by section 4945(a)(1) is 
assessed.
    (2) Cross reference. For rules relating to taxable events that are 
corrected within the correction period, defined in section 4963(e), see 
section 4961(a) and the regulations thereunder.

[T.D. 7215, 37 FR 23161, Oct. 31, 1972, as amended by T.D. 7299, 38 FR 
35305, Dec. 27, 1973; T.D. 7527, 42 FR 64625, Dec. 27, 1977; T.D. 8084, 
51 FR 16303, May 2, 1986]



Sec. 53.4945-2  Propaganda influencing legislation.

    (a) Propaganda influencing legislation, etc.--(1) In general. Under 
section 4945(d)(1) the term ``taxable expenditure'' includes any amount 
paid or incurred by a private foundation to carry on propaganda, or 
otherwise to attempt, to influence legislation. An expenditure is an 
attempt to influence legislation if it is for a direct or grass roots 
lobbying communication, as defined in Sec. 56.4911-2 (without reference 
to Sec. Sec. 56.4911-2(b)(3) and 56.4911-2(c)) and Sec. 56.4911-3. 
See, however, paragraph (d) of this section for exceptions to the 
general rule of this paragraph (a)(1).
    (2) Expenditures for membership communications. Section 56.4911-5, 
which provides special rules for electing public charities' 
communications with their members, does not apply to private 
foundations. Thus, whether a private foundation's communications with 
its members (assuming it has any) are lobbying communications is 
determined solely under Sec. 56.4911-2 and without reference to Sec. 
56.4911-5. However, where a private foundation makes a grant to an 
electing public charity, Sec. 56.4911-5 applies to the electing public 
charity's communications with its own members. Therefore, in the limited 
context of determining whether a private foundation's grant to an 
electing public charity is a taxable expenditure under section 4945, the 
Sec. 56.4911-5 membership rules apply. For example, if the grant is 
specifically earmarked for a communication from the electing public 
charity to its members and the communication is, because of Sec. 
56.4911-5, a nonlobbying communication, the grant is not a taxable 
expenditure under section 4945.
    (3) Jointly funded projects. A private foundation will not be 
treated as having paid or incurred any amount to attempt to influence 
legislation merely because it makes a grant to another organization upon 
the condition that the recipient obtain a matching support appropriation 
from a governmental body. In addition, a private foundation will not be 
treated as having made taxable expenditures of amounts paid or incurred 
in carrying on discussions with officials of governmental bodies 
provided that:
    (i) The subject of such discussions is a program which is jointly 
funded by the foundation and the Government or is a new program which 
may be jointly funded by the foundation and the Government,
    (ii) The discussions are undertaken for the purpose of exchanging 
data and information on the subject matter of the programs, and
    (iii) Such discussions are not undertaken by foundation managers in 
order to make any direct attempt to persuade governmental officials or 
employees to take particular positions on specific legislative issues 
other than such program.
    (4) Certain expenditures by recipients of program-related 
investments. Any amount paid or incurred by a recipient of a program-
related investment (as defined in Sec. 53.4944-3) in connection with

[[Page 173]]

an appearance before, or communication with, any legislative body with 
respect to legislation or proposed legislation of direct interest to 
such recipient shall not be attributed to the investing foundation, if:
    (i) The foundation does not earmark its funds to be used for any 
activities described in section 4945(d) (1) and
    (ii) A deduction under section 162 is allowable to the recipient for 
such amount.
    (5) Grants to public organizations--(i) In general. A grant by a 
private foundation to an organization described in section 509(a) (1), 
(2) or (3) does not constitute a taxable expenditure by the foundation 
under section 4945(d), other than under section 4945(d)(1), if the grant 
by the private foundation is not earmarked to be used for any activity 
described in section 4945(d) (2) or (5), is not earmarked to be used in 
a manner which would violate section 4945(d) (3) or (4), and there does 
not exist an agreement, oral or written, whereby the grantor foundation 
may cause the grantee to engage in any such prohibited activity or to 
select the recipient to which the grant is to be devoted. For purposes 
of this paragraph (a)(5)(i), a grant by a private foundation is 
earmarked if the grant is given pursuant to an agreement, oral or 
written, that the grant will be used for specific purposes. For the 
expenditure responsibility requirements with respect to organizations 
other than those described in section 509(a) (1), (2), or (3), see Sec. 
53.4945-5. For rules for determining whether grants to public charities 
are taxable expenditures under section 4945(d)(1), see paragraphs 
(a)(2), (a)(6) and (a)(7) of this section.
    (ii) Certain ``public'' organizations. For purposes of this section, 
an organization shall be considered a section 509(a)(1) organization if 
it is treated as such under subparagraph (4) of Sec. 53.4945-5(a).
    (6) Grants to public organizations that attempt to influence 
legislation--(i) General support grant. A general support grant by a 
private foundation to the organization described in section 509(a) (1), 
(2), or (3) (a ``public charity'' for purposes of paragraphs (a) (6) and 
(7) of this section) does not constitute a taxable expenditure under 
section 4945(d)(1) to the extent that the grant is not earmarked, within 
the meaning of Sec. 53.4945-2(a)(5)(i), to be used in an attempt to 
influence legislation. The preceding sentence applies without regard to 
whether the public charity has made the election under section 501(h).
    (ii) Specific project grant. A grant, by a private foundation to 
fund a specific project of a public charity is not a taxable expenditure 
by the foundation under section 4945(d)(1) to the extent that--
    (A) The grant is not earmarked, within the meaning of Sec. 53.4945-
2(a)(5)(i), to be used in an attempt to influence legislation, and
    (B) The amount of the grant, together with other grants by the same 
private foundation for the same project for the same year, does not 
exceed the amount budgeted, for the year of the grant, by the grantee 
organization for activities of the project that are not attempts to 
influence legislation. If the grant is for more than one year, the 
preceding sentence applies to each year of the grant with the amount of 
the grant measured by the amount actually disbursed by the private 
foundation in each year or divided equally between years, at the option 
of the private foundation. The same method of measuring the annual 
amount must be used in all years of a grant. This paragraph (a)(6)(ii) 
applies without regard to whether the public charity has made the 
election under section 501(h).
    (iii) Reliance upon grantee's budget. For purposes of determining 
the amount budgeted by a prospective grantee for specific project 
activities that are not attempts to influence legislation under 
paragraph (a)(6)(ii) of this section, a private foundation may rely on 
budget documents or other sufficient evidence supplied by the grantee 
organization (such as a signed statement by an authorized officer, 
director or trustee of such grantee organization) showing the proposed 
budget of the specific project, unless the private foundation doubts or, 
in light of all the facts and circumstances, reasonably should doubt the 
accuracy or reliability of the documents.
    (7) Grants to organizations that cease to be described in 
501(c)(3)--(i) Not taxable expenditure; conditions. A grant to a

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public charity (as defined in paragraph (a)(6)(i) of this section) that 
thereafter ceases to be an organization described in section 501(c)(3) 
by reason of its attempts to influence legislation is not a taxable 
expenditure if--
    (A) The grant meets the requirements of paragraph (a)(6) of this 
section,
    (B) The recipient organization had received a ruling or 
determination letter, or an advance ruling or determination letter, that 
it is described in sections 501(c)(3) and 509(a),
    (C) Notice of a change in the recipient organization's status has 
not been made to the public (such as by publication in the Internal 
Revenue Bulletin), and the private foundation has not acquired knowledge 
that the Internal Revenue Service has given notice to the recipient 
organization that it will be deleted from such status; and
    (D) The recipient organization is not controlled directly or 
indirectly by the private foundation. A recipient organization is 
controlled by a private foundation for this purpose if the private 
foundation and disqualified persons (defined in section 4946(a)(1) (A) 
through (H) with reference to the private foundation, by aggregating 
their votes or positions of authority, can cause or prevent action on 
legislative issues by the recipient.
    (ii) Examples. The provisions of paragraphs (a)(6) and (a)(7) of 
this section are illustrated by the following examples:

    Example 1. W, a private foundation, makes a general support grant to 
Z, a public charity described in section 509(a)(1). Z informs W that, as 
an insubstantial portion of its activities, Z attempts to influence the 
State legislature with regard to changes in the mental health laws. The 
use of the grant is not earmarked by W to be used in a manner that would 
violate section 4945(d)(1). Even if the grant is subsequently devoted by 
Z to its legislative activities, the grant by W is not a taxable 
expenditure under section 4945(d).
    Example 2. X, a private foundation, makes a specific project grant 
to Y University for the purpose of conducting research on the potential 
environmental effects of certain pesticides. X does not earmark the 
grant for any purpose that would violate section 4945(d)(1) and there is 
no oral or written agreement or understanding whereby X may cause Y to 
engage in any activity described in section 4945(d) (1), (2), or (5), or 
to select any recipient to which the grant may be devoted. Further, X 
determines, based on budget information supplied by Y, that Y's budget 
for the project does not contain any amount for attempts to influence 
legislation. X has no reason to doubt the accuracy or reliability of the 
budget information. Y uses most of the funds for the research project; 
however, Y expends a portion of the grant funds to send a representative 
to testify at Congressional hearings on a specific bill proposing 
certain pesticide control measures. The portion of the grant funds 
expended with respect to the Congressional hearings is not treated as a 
taxable expenditure by X under section 4945(d)(1).
    Example 3. M, a private foundation, makes a specific project grant 
of $150,000 to P, a public charity described in section 509(a)(1). In 
requesting the grant from M, P stated that the total budgeted cost of 
the project is $200,000, and that of this amount $20,000 is allocated to 
attempts to influence legislation related to the project. M relies on 
the budget figures provided by P in determining the amount P will spend 
on influencing legislation and M has no reason to doubt the accuracy or 
reliability of P's budget figures. In making the grant, M did not 
earmark any of the funds from the grant to be used for attempts to 
influence legislation. M's grant of $150,000 to P will not constitute a 
taxable expenditure under section 4945(d)(1) because M did not earmark 
any of the funds for attempts to influence legislation and because the 
amount of its grant ($150,000) does not exceed the amount allocated to 
specific project activities that are not attempts to influence 
legislation ($200,000-$20,000=$180,000).
    Example 4. Assume the same facts as in example (3), except that M's 
grant letter to P provides that M has the right to renegotiate the terms 
of the grant if there is a substantial deviation from those terms. This 
additional fact does not make M's grant a taxable expenditure under 
section 4945(d)(1).
    Example 5. Assume the same facts as in example (3), except that M 
made a specific project grant of $200,000 to P. Part of M's grant of 
$200,000 will constitute a taxable expenditure under section 4945(d)(1). 
The amount of the grant ($200,000) exceeds by $20,000 the amount P 
allocated to specific project activities that are not attempts to 
influence legislation ($180,000). M has made a taxable expenditure of 
$20,000.
    Example 6. Assume the same facts as example (3), except that M made 
a specific project grant of $180,000, and received from P an enforceable 
commitment that grant funds would not be used in connection with 
attempts to influence legislation. M's grant is not a taxable 
expenditure under section 4945(d)(1).
    Example 7. Assume the same facts as in example (3) except that M 
directed P to hire A, an individual, to expend $20,000 from the

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grant to engage in direct lobbying (within the meaning of Sec. 56.4911-
2(b)) and grass roots lobbying (within the meaning of Sec. 56.4911-
2(c)). P does not expend any other grant funds for lobbying activities. 
The $20,000 that is earmarked for direct lobbying and grass roots 
lobbying is a taxable expenditure under section 4945(d)(1).
    Example 8. R, a public charity described in section 509(a)(1), 
requested N, a private foundation, to make a general purpose grant to it 
to aid R in carrying out its exempt purpose. In making this request, R 
notified N that it had elected the expenditure test under section 501(h) 
and that it expected to attempt to influence legislation in areas 
related to its exempt purpose. Since its formation, R generally has had 
exempt purpose expenditures (as defined in Sec. 56.4911-4) in excess of 
$7,000,000 in each of its taxable years, and has budgeted in excess of 
$7,000,000 of exempt purpose expenditures for the year of the grant. N 
made a grant of $200,000 to R. N did not earmark the funds for R's 
attempt to influence legislation. The general purpose grant by N does 
not constitute a taxable expenditure under section 4945(d)(1).
    Example 9. Assume the same facts as in example (8), except that N 
learns that R has had excess lobbying expenditures (within the meaning 
of Sec. 56.4911-1(b)) in some prior years. N also learns that in no 
year has R's lobbying or grass roots expenditures (within the meaning of 
Sec. 56.4911-2 (a) and (c)) exceeded the corresponding ceiling amount 
(within the meaning of Sec. 1.501(h)-3(c) (3) and (6)). N then makes 
the grant to R. After receiving the grant, R spends a large portion of 
its funds on influencing legislation and, as a consequence, is denied 
exemption from tax, as an organization described in section 501(c)(3), 
under section 501(h) and Sec. 1.501(h)-3. No disqualified person with 
respect to N controlled, in whole or in part, R's attempts to influence 
legislation. The general purpose grant will not constitute a taxable 
expenditure under section 4945(d)(1).
    Example 10. X, a private foundation, makes a specific project grant 
to Y, a public charity described in section 509(a). In requesting the 
grant, Y stated that it planned to use the funds to purchase a computer 
for purpose of computerizing its research files and that the grant will 
not be used to influence legislation. Two years after X makes the grant, 
X discovers that Y has also used the computer for purposes of 
maintaining and updating the mailing list for Y's lobbying newsletter. 
Because X did not earmark any of the grant funds to be used for attempts 
to influence legislation and because X had no reason to doubt the 
accuracy or reliability of Y's documents representing that the grant 
would not be used to influence legislation, X's grant is not treated as 
a taxable expenditure.
    Example 11. G, a private foundation, makes a specific project grant 
of $300,000 to L, a public charity described in section 509(a)(1) for a 
three-year specific project studying child care problems. L provides 
budget material indicating that the specific project will expend 
$200,000 in each of three years. L's budget materials indicate that 
attempts to influence legislation will amount to $10,000 in the first 
year, $20,000 in the second year and $100,000 in the third year. G 
intends to pay its $300,000 grant over three years as follows: $200,000 
in the first year, $50,000 in the second year and $50,000 in the third 
year. The amount of the grant actually disbursed by G in the first year 
of the grant exceeds the nonlobbying expenditures of L in that year. 
However, because the amount of the grant in each of the three years, 
when divided equally among the three years ($100,000 for each year), is 
not more than the nonlobbying expenditures of L on the specific project 
for any of the three years, none of the grant is treated as a taxable 
expenditure under section 4945(d)(1).
    Example 12. P, a private foundation, makes a $120,000 specific 
project grant to C, a public charity described in section 509(a) for a 
three-year project. P intends to pay its grant to C in three equal 
annual installments of $40,000. C provides budget material indicating 
that the specific project will expend $100,000 in each of three years. 
C's budget materials, which P reasonably does not doubt, indicate that 
the project's attempts to influence legislation will amount to $50,000 
in each of the three years. After P pays the first annual installment to 
C, but before P pays the second installment to C, reliable information 
comes to P's attention that C has spent $90,000 of the project's 
$100,000 first-year budget on attempts to influence legislation. This 
information causes P to doubt the accuracy and reliability of C's budget 
materials. Because of the information, P does not pay the second-year 
installment to C. P's payment of the first installment of $40,000 is not 
a taxable expenditure under section 4945(d)(1) because the grant in the 
first year is not more than the nonlobbying expenditures C projected in 
its budget materials that P reasonably did not doubt.
    Example 13. Assume the same facts as in Example (12), except that P 
pays the second-year installment of $40,000 to C. In the project's 
second year, C once again spends $90,000 of the project's $100,000 
annual budget in attempts to influence legislation. Because P doubts or 
reasonably should doubt the accuracy or reliability of C's budget 
materials when P makes the second-year grant payment, P may not rely 
upon C's budget documents at that time. Accordingly, although none of 
the $40,000 paid in the first installment is a taxable expenditure, only 
$10,000 ($100,000 minus $90,000) of the second-year grant payment is not 
a taxable expenditure.

[[Page 176]]

The remaining $30,000 of the second installment is a taxable expenditure 
within the meaning of section 4945(d)(1).
    Example 14. B, a private foundation, makes a specific project grant 
to C, a public charity described in section 509(a), of $40,000 for the 
purpose of conducting a study on the effectiveness of seat belts in 
preventing traffic deaths. B did not earmark any of the grant for 
attempts to influence legislation. In requesting the grant from B, C 
submitted a budget of $100,000 for the project. The budget contained 
expenses for postage and mailing, computer time, advertising, consulting 
services, salaries, printing, advertising, and similar categories of 
expenses. C also submitted to B a statement, signed by an officer of C, 
that 30% of the budgeted funds would be devoted to attempts to influence 
legislation within the meaning of section 4945. B has no reason to doubt 
the accuracy of the budget figures or the statement. B may rely on the 
budget figures and signed statement provided by C in determining the 
amount C will spend on influencing legislation. B's grant to C will not 
constitute a taxable expenditure under section 4945(d)(1), because the 
amount of the grant does not exceed the amount allocated to specific 
project activities that are not attempts to influence legislation.

    (b)-(c) [Reserved]
    (d) Exceptions--(1) Nonpartisan analysis, study, or research--(i) In 
general. A communication is not a lobbying communication, for purposes 
of Sec. 53.4945-2(a)(1), if the communication constitutes engaging in 
nonpartisan analysis, study or research and making available to the 
general public or a segment or members thereof or to governmental 
bodies, officials, or employees the results of such work. Accordingly, 
an expenditure for such a communication does not constitute a taxable 
expenditure under section 4945(d)(1) and Sec. 53.4945-2(a)(1).
    (ii) Nonpartisan analysis, study, or research. For purposes of 
section 4945(e), ``nonpartisan analysis, study, or research'' means an 
independent and objective exposition of a particular subject matter, 
including any activity that is ``educational'' within the meaning of 
Sec. 1.501(c)(3)-1(d)(3). Thus, ``nonpartisan analysis, study, or 
research'' may advocate a particular position or viewpoint so long as 
there is a sufficiently full and fair exposition of the pertinent facts 
to enable the public or an individual to form an independent opinion or 
conclusion. On the other hand, the mere presentation of unsupported 
opinion does not qualify as ``nonpartisan analysis, study, or 
research''.
    (iii) Presentation as part of a series. Normally, whether a 
publication or broadcast qualifies as ``nonpartisan analysis, study, or 
research'' will be determined on a presentation-by-presentation basis. 
However, if a publication or broadcast is one of a series prepared or 
supported by a private foundation and the series as a whole meets the 
standards of subdivision (ii) of this subparagraph, then any individual 
publication or broadcast within the series will not result in a taxable 
expenditure even though such individual broadcast or publication does 
not, by itself, meet the standards of subdivision (ii) of this 
subparagraph. Whether a broadcast or publication is considered part of a 
series will ordinarily depend on all the facts and circumstances of each 
particular situation. However, with respect to broadcast activities, all 
broadcasts within any period of 6 consecutive months will ordinarily be 
eligible to be considered as part of a series. If a private foundation 
times or channels a part of a series which is described in this 
subdivision in a manner designed to influence the general public or the 
action of a legislative body with respect to a specific legislative 
proposal in violation of section 4945(d)(1), the expenses of preparing 
and distributing such part of the analysis, study, or research will be a 
taxable expenditure under this section.
    (iv) Making available results of analysis, study, or research. A 
private foundation may choose any suitable means, including oral or 
written presentations, to distribute the results of its nonpartisan 
analysis, study, or research, with or without charge. Such means include 
distribution of reprints of speeches, articles, and reports (including 
the report required under section 6056); presentation of information 
through conferences, meetings, and discussions; and dissemination to the 
news media, including radio, television, and newspapers, and to other 
public forums. For purposes of this

[[Page 177]]

paragraph (d)(1)(iv), such communications may not be limited to, or be 
directed toward, persons who are interested solely in one side of a 
particular issue.
    (v) Subsequent lobbying use of certain analysis, study, or 
research--(A) In general. Even though certain analysis, study or 
research is initially within the exception for nonpartisan analysis, 
study, or research, subsequent use of that analysis, study or research 
for grass roots lobbying may cause that analysis, study or research to 
be treated as a grass roots lobbying communication that is not within 
the exception for nonpartisan analysis, study, or research. This 
paragraph (d)(1)(v) of this section does not cause any analysis, study, 
or research to be considered a direct lobbying communication. For rules 
regarding when analysis, study, or research is treated as a grass roots 
lobbying communication that is not within the scope of the exception for 
nonpartisan analysis, study, or research, see Sec. 56.4911-2(b)(2)(v).
    (B) Special rule for grants to public charities. This paragraph 
(d)(1)(v)(B) of this section applies where a public charity uses a 
private foundation grant to finance, in whole or in part, a nonlobbying 
communication that is subsequently used in lobbying, causing the public 
charity's expenditures for the communication to be treated as lobbying 
expenditures under the subsequent use. In such a case, the private 
foundation's grant will ordinarily not be characterized as a lobbying 
expenditure by virtue of the subsequent use rule. The only situations 
where the private foundation's grant will be treated as a lobbying 
expenditure under the subsequent use rule are where the private 
foundation's primary purpose in making the grant to the public charity 
was for lobbying or where, at the time of making the grant, the private 
foundation knows (or in light of all the facts and circumstances 
reasonably should know) that the public charity's primary purpose in 
preparing the communication to be funded by the grant is for use in 
lobbying.
    (vi) Directly encouraging action by recipients of a communication. A 
communication that reflects a view on specific legislation is not within 
the nonpartisan analysis, study, or research exception of this Sec. 
53.4945-2(d)(1) if the communication directly encourages the recipient 
to take action with respect to such legislation. For purposes of this 
section, a communication directly encourages the recipient to take 
action with respect to legislation if the communication is described in 
one or more of Sec. 56.4911-2(b)(2)(iii)(A) through (C). As described 
in Sec. 56.4911-2(b)(2)(iv), a communication would encourage the 
recipient to take action with respect to legislation, but not directly 
encourage such action, if the communication does no more than 
specifically identify one or more legislators who will vote on the 
legislation as: opposing the communication's view with respect to the 
legislation; being undecided with respect to the legislation; being the 
recipient's representative in the legislature; or being a member of the 
legislative committee or subcommittee that will consider the 
legislation.
    (vii) Examples. The provisions of this paragraph may be illustrated 
by the following examples:

    Example 1. M, a private foundation, establishes a research project 
to collect information for the purpose of showing the dangers of the use 
of pesticides in raising crops. The information collected includes data 
with respect to proposed legislation, pending before several State 
legislatures, which would ban the use of pesticides. The project takes 
favorable positions on such legislation without producing a sufficiently 
full and fair exposition of the pertinent facts to enable the public or 
an individual to form an independent opinion or conclusion on the pros 
and cons of the use of pesticides. This project is not within the 
exception for nonpartisan analysis, study, or research because it is 
designed to present information merely on one side of the legislative 
controversy.
    Example 2. N, a private foundation, establishes a research project 
to collect information concerning the dangers of the use of pesticides 
in raising crops for the ostensible purpose of examining and reporting 
information as to the pros and cons of the use of pesticides in raising 
crops. The information is collected and distributed in the form of a 
published report which analyzes the effects and costs of the use and 
nonuse of various pesticides under various conditions on humans, 
animals, and crops. The report also presents the advantages, 
disadvantages, and economic cost of allowing the continued use of 
pesticides unabated, of controlling the use of pesticides, and of 
developing alternatives to pesticides. Even if the report sets forth

[[Page 178]]

conclusions that the disadvantages as a result of using pesticides are 
greater than the advantages of using pesticides and that prompt 
legislative regulation of the use of pesticides is needed, the project 
is within the exception for nonpartisan analysis, study or research 
since it is designed to present information on both sides of the 
legislative controversy and presents a sufficiently full and fair 
exposition of the pertinent facts to enable the public or an individual 
to form an independent opinion or conclusion.
    Example 3. O, a private foundation, establishes a research project 
to collect information on the presence or absence of disease in humans 
from eating food grown with pesticides and the presence or absence of 
disease in humans from eating food not grown with pesticides. As part of 
the research project, O hires a consultant who prepares a ``fact sheet'' 
which calls for the curtailment of the use of pesticides and which 
addresses itself to the merits of several specific legislative proposals 
to curtail the use of pesticides in raising crops which are currently 
pending before State legislatures. The ``fact sheet'' presents reports 
of experimental evidence tending to support its conclusions but omits 
any reference to reports of experimental evidence tending to dispute its 
conclusions. O distributes 10,000 copies to citizens' groups. 
Expenditures by O in connection with this work of the consultant are not 
within the exception for nonpartisan analysis, study, or research.
    Example 4. P publishes a bi-monthly newsletter to collect and report 
all published materials, ongoing research, and new developments with 
regard to the use of pesticides in raising crops. The newsletter also 
includes notices of proposed pesticide legislation with impartial 
summaries of the provisions and debates on such legislation. The 
newsletter does not encourage recipients to take action with respect to 
such legislation, but is designed to present information on both sides 
of the legislative controversy and does present information fully and 
fairly. It is within the exception for nonpartisan analysis, study, or 
research.
    Example 5. X is satisfied that A, a member of the faculty of Y 
University, is exceptionally well qualified to undertake a project 
involving a comprehensive study of the effects of pesticides on crop 
yields. Consequently, X makes a grant to A to underwrite the cost of the 
study and of the preparation of a book on the effect of pesticides on 
crop yields. X does not take any position on the issues or control the 
content of A's output. A produces a book which concludes that the use of 
pesticides often has a favorable effect on crop yields, and on that 
basis argues against pending bills which would ban the use of 
pesticides. A's book contains a sufficiently full and fair exposition of 
the pertinent facts, including known or potential disadvantages of the 
use of pesticides, to enable the public or an individual to form an 
independent opinion or conclusion as to whether pesticides should be 
banned as provided in the pending bills. The book does not directly 
encourage readers to take action with respect to the pending bills. 
Consequently, the book is within the exception for nonpartisan analysis, 
study, or research.
    Example 6. Assume the same facts as Example (2), except that, 
instead of issuing a report, X presents within a period of 6 consecutive 
months a two-program television series relating to the pesticide issue. 
The first program contains information, arguments, and conclusions 
favoring legislation to restrict the use of pesticides. The second 
program contains information, arguments, and conclusions opposing 
legislation to restrict the use of pesticides. The programs are 
broadcast within 6 months of each other during commensurate periods of 
prime time. X's programs are within the exception for nonpartisan 
analysis, study, or research. Although neither program individually 
could be regarded as nonpartisan, the series of two programs constitutes 
a balanced presentation.
    Example 7. Assume the same facts as Example (6), except that X 
arranged for televising the program favoring legislation to restrict the 
use of pesticides at 8 p.m. on a Thursday evening and for televising the 
program opposing such legislation at 7 a.m. on a Sunday morning. X's 
presentation is not within the exception for nonpartisan analysis, 
study, or research, since X disseminated its information in a manner 
prejudicial to one side of the legislative controversy.
    Example 8. Organization Z researches, writes, prints and distributes 
a study on the use and effects of pesticide X. A bill is pending in the 
U.S. Senate to ban the use of pesticide X. Z's study leads to the 
conclusion that pesticide X is extremely harmful and that the bill 
pending in the U.S. Senate is an appropriate and much needed remedy to 
solve the problems caused by pesticide X. The study contains a 
sufficiently full and fair exposition of the pertinent facts, including 
known or potential advantages of the use of pesticide X, to enable the 
public or an individual to form an independent opinion or conclusion as 
to whether pesticides should be banned as provided in the pending bills. 
In its analysis of the pending bill, the study names certain undecided 
Senators on the Senate committee considering the bill. Although the 
study meets the three part test for determining whether a communication 
is a grass roots lobbying communication, the study is within the 
exception for nonpartisan analysis, study or research, because it does 
not directly encourage recipients of the communication to urge a 
legislator to oppose the bill.
    Example 9. Assume the same facts as in Example (8), except that, 
after stating support

[[Page 179]]

for the pending bill, the study concludes: ``You should write to the 
undecided committee members to support this crucial bill.'' The study is 
not within the exception for nonpartisan analysis, study or research 
because it directly encourages the recipients to urge a legislator to 
support a specific piece of legislation.
    Example 10. Organization X plans to conduct a lobbying campaign with 
respect to illegal drug use in the United States. It incurs $5,000 in 
expenses to conduct research and prepare an extensive report primarily 
for use in the lobbying campaign. Although the detailed report discusses 
specific pending legislation and reaches the conclusion that the 
legislation would reduce illegal drug use, the report contains a 
sufficiently full and fair exposition of the pertinent facts to enable 
the public or an individual to form an independent conclusion regarding 
the effect of the legislation. The report does not encourage readers to 
contact legislators regarding the legislation. Accordingly, the report 
does not, in and of itself, constitute a lobbying communication.
    Copies of the report are available to the public at X's office, but 
X does not actively distribute the report or otherwise seek to make the 
contents of the report available to the general public. Whether or not 
X's distribution is sufficient to meet the requirement in Sec. 53.4945-
2(d)(1)(iv) that a nonpartisan communication be made available, X's 
distribution is not substantial (for purposes of Sec. Sec. 53.4945-
2(D)(1)(v) and 56.4911-2(b)(2)(v)) in light of all of the facts and 
circumstances, including the normal distribution pattern of similar 
nonpartisan reports. X then mails copies of the report, along with a 
letter, to 10,000 individuals on X's mailing list. In the letter, X 
requests that individuals contact legislators urging passage of the 
legislation discussed in the report. Because X's research and report 
were primarily undertaken by X for lobbying purposes and X did not make 
a substantial distribution of the report (without an accompanying 
lobbying message) prior to or contemporaneously with the use of the 
report in lobbying, the report is a grass roots lobbying communication 
that is not within the exception for nonpartisan analysis, study or 
research. Thus, the expenditures for preparing and mailing both the 
report and the letter are taxable expenditures under section 4945.
    Example 11. Assume the same facts as in Example (10), except that 
before using the report in the lobbying campaign, X sends the research 
and report (without an accompanying lobbying message) to universities 
and newspapers. At the same time, X also advertises the availability of 
the report in its newsletter. This distribution is similar in scope to 
the normal distribution pattern of similar nonpartisan reports. In light 
of all of the facts and circumstances, X's distribution of the report is 
substantial. Because of X's substantial distribution of the report, X's 
primary purpose will be considered to be other than for use in lobbying 
and the report will not be considered a grass roots lobbying 
communication. Accordingly, only the expenditures for copying and 
mailing the report to the 10,000 individuals on X's mailing list, as 
well as for preparing and mailing the letter, are expenditures for grass 
roots lobbying communications, and are thus taxable expenditures under 
section 4945.
    Example 12. Organization M pays for a bumper sticker that reads: 
``STOP ABORTION: Vote NO on Prop. X!'' M also pays for a 30-second 
television advertisement and a billboard that similarly advocate 
opposition to Prop. X. In light of the limited scope of the 
communications, none of the communications is within the exception for 
nonpartisan analysis, study or research. First, none of the 
communications rises to the level of analysis, study or research. 
Second, none of the communications is nonpartisan because none contains 
a sufficiently full and fair exposition of the pertinent facts to enable 
the public or an individual to form an independent opinion or 
conclusion. Thus, each communication is a lobbying communication.

    (2) Technical advice or assistance--(i) In general. Amounts paid or 
incurred in connection with providing technical advice or assistance to 
a governmental body, a governmental committee, or a subdivision of 
either of the foregoing, in response to a written request by such body, 
committee, or subdivision do not constitute taxable expenditures for 
purposes of this section. Under this exception, the request for 
assistance or advice must be made in the name of the requesting 
governmental body, committee or subdivision rather than an individual 
member thereof. Similarly, the response to such request must be 
available to every member of the requesting body, committee or 
subdivision. For example, in the case of a written response to a request 
for technical advice or assistance from a congressional committee, the 
response will be considered available to every member of the requesting 
committee if the response is submitted to the person making such request 
in the name of the committee and it is made clear that the response is 
for the use of all the members of the committee.
    (ii) Nature of technical advice or assistance. ``Technical advice or 
assistance'' may be given as a result of knowledge

[[Page 180]]

or skill in a given area. Because such assistance or advice may be given 
only at the express request of a governmental body, committee or 
subdivision, the oral or written presentation of such assistance or 
advice need not qualify as nonpartisan analysis, study or research. The 
offering of opinions or recommendations will ordinarily qualify under 
this exception only if such opinions or recommendations are specifically 
requested by the governmental body, committee or subdivision or are 
directly related to the materials so requested.
    (iii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. A congressional committee is studying the feasibility of 
legislation to provide funds for scholarships to U.S. students attending 
schools abroad. X, a private foundation which has engaged in a private 
scholarship program of this type, is asked, in writing, by the committee 
to describe the manner in which it selects candidates for its program. 
X's response disclosing its methods of selection constitutes technical 
advice or assistance.
    Example 2. Assume the same facts as Example (1), except that X's 
response not only includes a description of its own grant-making 
procedures, but also its views regarding the wisdom of adopting such a 
program. Since such views are directly related to the subject matter of 
the request for technical advice or assistance, expenditures paid or 
incurred with respect to the presentation of such views would not 
constitute taxable expenditures. However, expenditures paid or incurred 
with respect to a response which is not directly related to the subject 
matter of the request for technical advice or assistance would 
constitute taxable expenditures unless the presentation can qualify as 
the making available of nonpartisan analysis, study or research.
    Example 3. Assume the same facts as Example (1), except that X is 
requested, in addition, to give any views it considers relevant. A 
response to this request giving opinions which are relevant to the 
committee's consideration of the scholarship program but which are not 
necessarily directly related to X's scholarship program, such as 
discussions of alternative scholarships programs and their relative 
merits, would qualify as ``technical advice or assistance'', and 
expenditures paid or incurred with respect to such response would not 
constitute taxable expenditures.
    Example 4. A, an official of the State Department, makes a written 
request in his official capacity for information from foundation Y 
relating to the economic development of country M and for the opinions 
of Y as to the proper position of the United States in pending 
negotiations with M concerning a proposed treaty involving a program of 
economic and technical aid to M. Y's furnishing of such information and 
opinions constitutes technical advice or assistance.
    Example 5. In response to a telephone inquiry from Senator X's 
staff, organization B sends Senator X a report concluding that the 
Senate should not advise and consent to the nomination of Z to serve as 
a Supreme Court Justice. Because the request was not in writing, and 
also because the request was not from the Senate itself or from a 
committee or subcommittee, B's report is not within the scope of the 
exception for responses to requests for technical advice. Accordingly, 
B's report is a lobbying communication unless the report is within the 
scope of the exception for nonpartisan analysis, study or research.
    Example 6. Assume the same facts as in Example (5), except that B's 
report is sent in response to a written request that Senator X sends to 
B. The request from Senator X is a request from the Senator as an 
individual member of the Senate rather than from the Senate itself or 
from a committee or subcommittee. Accordingly, B's report is not within 
the scope of the exception for responses to requests for technical 
advice and is a lobbying conmmunication unless the report is within the 
scope of the exception for nonpartisan analysis, study or research.
    Example 7. Assume the same facts as in Example (6), except that B's 
report is sent in response to a written request from the Senate 
committee that is considering the nomination for an evaluation of the 
nominee's legal writings and a recommendation as to whether the 
candidate is or is not qualified to serve on the Supreme Court. The 
report is within the scope of the exception for responses to requests 
for technical advice and is not a lobbying communication.

    (3) Decisions affecting the powers, duties, etc., of a private 
foundation--(i) In general. Paragraph (c) of this section does not apply 
to any amount paid or incurred in connection with an appearance before, 
or communication with, any legislative body with respect to a possible 
decision of such body which might affect the existence of the private 
foundation, its powers and duties, its tax-exempt status, or the 
deductibility of contributions to such foundation. Under this exception, 
a foundation may communicate with the entire legislative body, 
committees or subcommittees of such legislative body, individual 
congressmen or legislators,

[[Page 181]]

members of their staffs, or representatives of the executive branch, who 
are involved in the legislative process, if such communication is 
limited to the prescribed subjects. Similarly, the foundation may make 
expenditures in order to initiate legislation if such legislation 
concerns only matters which might affect the existence of the private 
foundation, its powers and duties, its tax-exempt status, or the 
deductibility of contributions to such foundation.
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. A bill is being considered by Congress which would, if 
enacted, restrict the power of a private foundation to engage in 
transactions with certain related persons. Under the proposed bill a 
private foundation would lose its exemption from taxation if it engages 
in such transactions. W, a private foundation, writes to the 
congressional committee considering the bill, arguing that the enactment 
of such a bill would not be advisable, and subsequently appears before 
such committee to make its arguments. In addition, W requests that the 
congressional committee consider modification of the 2 percent de 
minimis rule of section 4943(c) (2) (C). Expenditures paid or incurred 
with respect to such submissions do not constitute taxable expenditures 
since they are made with respect to a possible decision of Congress 
which might affect the existence of the private foundation, its powers 
and duties, its tax-exempt status, or the deduction of contributions to 
such foundation.
    Example 2. A bill being considered in a State legislature is 
designed to implement the requirements of section 508(e) of the Internal 
Revenue Code of 1954. Under such section, a private foundation is 
required to make certain amendments to its governing instrument. X, a 
private foundation, makes a submission to the legislature which proposes 
alternative measures which might be taken in lieu of the proposed bill. 
X also arranges to have its president contact certain State legislators 
with regard to this bill. Expenditures paid or incurred in making such 
submission and in contacting the State legislators do not constitute 
taxable expenditures since they are made with respect to a possible 
decision of such State legislature which might affect the existence of 
the private foundation, its powers and duties, its tax-exempt status, or 
the deduction of contributions to such foundation.
    Example 3. A bill is being considered by a State legislature under 
which the State would assume certain responsibilities for nursing care 
of the aged. Y, a private foundation which hitherto has engaged in such 
activities, appears before the State legislature and contends that such 
activities can be better performed by privately supported organizations. 
Expenditures paid or incurred with respect to such appearance are not 
made with respect to possible decisions of the State legislature which 
might affect the existence of the private foundation, its powers and 
duties, its tax-exempt status, or the deduction of contributions to such 
foundation, but rather merely affect the scope of the private 
foundation's future activities.
    Example 4. A State legislature is considering the annual 
appropriations bill. Z, a private foundation which had hitherto 
performed contract research for the State, appears before the 
appropriations committee in order to attempt to persuade the committee 
of the advisability of continuing the program. Expenditures paid or 
incurred with respect to such appearance are not made with respect to 
possible decisions of the State legislature which might affect the 
existence of the private foundation, its powers and duties, its tax-
exempt status, or the deduction of contributions to such foundation, but 
rather merely affect the scope of the private foundation's future 
activities.

    (4) Examination and discussions of broad social, economic, and 
similar problems. Examinations and discussions of broad social, 
economic, and similar problems are neither direct lobbying 
communications under Sec. 56.4911-2(b)(1) nor grass roots lobbying 
communications under Sec. 56.4911-2(b)(2) even if the problems are of 
the type with which government would be expected to deal ultimately. 
Thus, under Sec. Sec. 56.4911-2(b) (1) and (2), lobbying communications 
do not include public discussion, or communications with members of 
legislative bodies or governmental employees, the general subject of 
which is also the subject of legislation before a legislative body, so 
long as such discussion does not address itself to the merits of a 
specific legislative proposal and so long as such discussion does not 
directly encourage recipients to take action with respect to 
legislation. For example, this paragraph (d)(4) excludes from grass 
roots lobbying under Sec. 56.4911(b)(2) an organization's discussions 
of problems such as environmental pollution or population growth that 
are being considered by Congress and various State legislatures, but 
only where the discussions are not directly addressed to specific 
legislation being considered, and only where the

[[Page 182]]

discussions do not directly encourage recipients of the communication to 
contact a legislator, an employee of a legislative body, or a government 
official or employee who may participate in the formulation of 
legislation.

[T.D. 7215, 37 FR 23161, Oct. 31, 1972; 37 FR 23918, Nov. 11, 1972, as 
amended by T.D. 8308, 55 FR 35594, Aug. 31, 1990]



Sec. 53.4945-3  Influencing elections and carrying on voter registration
drives.

    (a) Expenditures to influence elections or carry on voter 
registration drives--(1) In general. Under section 4945(d) (2), the term 
``taxable expenditure'' includes any amount paid or incurred by a 
private foundation to influence the outcome of any specific public 
election or to carry on, directly or indirectly, any voter registration 
drive, unless such amount is paid or incurred by an organization 
described in section 4945(f). However, for treatment of nonearmarked 
grants to public organizations, see Sec. 53.4945-2(a) (5) and for 
treatment of certain earmarked grants to organizations described in 
section 4945(f), see paragraph (b) (2) of this section.
    (2) Influencing the outcome of a specific public election. For 
purposes of this section, an organization shall be considered to be 
influencing the outcome of any specific public election if it 
participates or intervenes, directly or indirectly, in any political 
campaign on behalf of or in opposition to any candidate for public 
office. The term candidate for public office means an individual who 
offers himself, or is proposed by others, as a contestant for an 
elective public office, whether such office be national, State or local. 
Activities which constitute participation or intervention in a political 
campaign on behalf of or in opposition to a candidate include, but are 
not limited to:
    (i) Publishing or distributing written or printed statements or 
making oral statements on behalf of or in opposition to such a 
candidate;
    (ii) Paying salaries or expenses of campaign workers; and
    (iii) Conducting or paying the expenses of conducting a voter-
registration drive limited to the geographic area covered by the 
campaign.
    (b) Nonpartisan activities carried on by certain organizations--(1) 
In general. If an organization meets the requirements described in 
section 4945(f), an amount paid or incurred by such organization shall 
not be considered a taxable expenditure even though the use of such 
amount is otherwise described in section 4945(d) (2). Such requirements 
are:
    (i) The organization is described in section 501(c) (3) and exempt 
from taxation under section 501(a);
    (ii) The activities of the organization are nonpartisan, are not 
confined to one specific election period, and are carried on in five or 
more States;
    (iii) The organization expends at least 85 percent of its income 
directly for the active conduct (within the meaning of section 4942(j) 
(3) and the regulations thereunder) of the activities constituting the 
purpose or function for which it is organized and operated;
    (iv) The organization receives at least 85 percent of its support 
(other than gross investment income as defined in section 509(e)) from 
exempt organizations, the general public, governmental units described 
in section 170(c) (1), or any combination of the foregoing; the 
organization does not receive more than 25 percent of its support (other 
than gross investment income) from any one exempt organization (for this 
purpose treating private foundations which are described in section 
4946(a) (1) (H) with respect to each other as one exempt organization); 
and not more than half of the support of the organization is received 
from gross investment income; and
    (v) Contributions to the organization for voter registration drives 
are not subject to conditions that they may be used only in specified 
States, possessions of the United States, or political subdivisions or 
other areas of any of the foregoing, or the District of Columbia, or 
that they may be used in only one specific election period.
    (2) Grants to section 4945(f) organizations. If a private foundation 
makes a grant to an organization described in section 4945(f) (whether 
or not such grantee is a private foundation as defined in section 
509(a)), such grant will not be treated as a taxable expenditure

[[Page 183]]

under section 4945(d) (2) or (4). Even if a grant to such an 
organization is earmarked for voter registration purposes generally, 
such a grant will not be treated as a taxable expenditure under section 
4945(d) (2) or (4) as long as such earmarking does not violate section 
4945(f) (5).
    (3) Period for determining support--(i) In general. The 
determination whether an organization meets the support test in section 
4945(f) (4) for any taxable year is to be made by aggregating all 
amounts of support received by the organization during the taxable year 
and the immediately preceding four taxable years. However, the support 
received in any taxable year which begins before January 1, 1970, shall 
be excluded.
    (ii) New organizations and organizations with no preceding taxable 
years beginning after December 31, 1969. Except as provided in 
subparagraph (4) of this paragraph, in the case of a new organization or 
an organization with no taxable years that begin after December 31, 
1969, and immediately precede the taxable year in question, the 
requirements of the support test in section 4945(f)(4) will be 
considered as met for the taxable year if such requirements are met by 
the end of the taxable year.
    (iii) Organization with three or fewer preceding taxable years. In 
the case of an organization which has been in existence for at least 1 
but fewer than 4 preceding taxable years beginning after December 31, 
1969, the determination whether such organization meets the requirements 
of the support test in section 4945(f)(4) for the taxable year is to be 
made by taking into account all the support received by such 
organization during the taxable year and during each preceding taxable 
year beginning after December 31, 1969.
    (4) Advance rulings. An organization will be given an advance ruling 
that it is an organization described in section 4945(f) for its first 
taxable year of operation beginning after October 30, 1972, or for its 
first taxable year of operation beginning after December 31, 1969, if it 
submits evidence establishing that it can reasonably be expected to meet 
the tests under section 4945(f) for such taxable year. An organization 
which, pursuant to this subparagraph, has been treated as an 
organization described in section 4945(f) for a taxable year (without 
withdrawal of such treatment by notification from the Internal Revenue 
Service during such year), but which actually fails to meet the 
requirements of section 4945(f) for such taxable year, will not be 
treated as an organization described in section 4945(f) as of the first 
day of its next taxable year (for purposes of making any determination 
under the internal revenue laws with respect to such organization) and 
until such time as the organization does meet the requirements of 
section 4945(f). For purposes of section 4945, the status of grants or 
contributions with respect to grantors or contributors to such 
organization will not be affected until notice of change of status of 
such organization is made to the public (such as by publication in the 
Internal Revenue Bulletin). The preceding sentence shall not apply, 
however, if the grantor or contributor was responsible for, or was aware 
of, the fact that the organization did not satisfy section 4945(f) at 
the end of the taxable year with respect to which the organization had 
obtained an advance ruling or a determination letter that it was a 
section 4945(f) organization, or acquired knowledge that the Internal 
Revenue Service had given notice to such organization that it would be 
deleted from classification as a section 4945(f) organization.

[T.D. 7215, 37 FR 23161, Oct. 31, 1972; 37 FR 23918, Nov. 11, 1972]



Sec. 53.4945-4  Grants to individuals.

    (a) Grants to individuals--(1) In general. Under section 4945(d) (3) 
the term ``taxable expenditure'' includes any amount paid or incurred by 
a private foundation as a grant to an individual for travel, study, or 
other similar purposes by such individual unless the grant satisfies the 
requirements of section 4945(g). Grants to individuals which are not 
taxable expenditures because made in accordance with the requirements of 
section 4945(g) may result in the imposition of excise taxes under other 
provisions of chapter 42.
    (2) ``Grants'' defined. For purposes of section 4945, the term 
``grants'' shall include, but is not limited to, such expenditures as 
scholarships, fellowships, internships, prizes, and awards. Grants

[[Page 184]]

shall also include loans for purposes described in section 170(c) (2) 
(B) and ``program related investments'' (such as investments in small 
businesses in central cities or in businesses which assist in 
neighborhood renovation). Similarly, ``grants'' include such 
expenditures as payments to exempt organizations to be used in 
furtherance of such recipient organizations' exempt purposes whether or 
not such payments are solicited by such recipient organizations. 
Conversely, ``grants'' do not ordinarily include salaries or other 
compensation to employees. For example, ``grants'' do not ordinarily 
include educational payments to employees which are includible in the 
employees' incomes pursuant to section 61. In addition, ``grants'' do 
not ordinarily include payments (including salaries, consultants' fees 
and reimbursement for travel expenses such as transportation, board, and 
lodging) to persons (regardless of whether such persons are individuals) 
for personal services in assisting a foundation in planning, evaluating 
or developing projects or areas of program activity by consulting, 
advising, or participating in conferences organized by the foundation.
    (3) Requirements for individual grants--(i) Grants for other than 
section 4945(d)(3) purposes. A grant to an individual for purposes other 
than those described in section 4945(d) (3) is not a taxable expenditure 
within the meaning of section 4945(d) (3). For example, if a foundation 
makes grants to indigent individuals to enable them to purchase 
furniture, such grants are not taxable expenditures within the meaning 
of section 4945(d) (3) even if the requirements of section 4945(g) are 
not met.
    (ii) Grants for section 4945(d) (3) purposes. Under section 4945(g), 
a grant to an individual for travel, study, or other similar purposes is 
not a ``taxable expenditure'' only if:
    (a) The grant is awarded on an objective and nondiscriminatory basis 
(within the meaning of paragraph (b) of this section);
    (b) The grant is made pursuant to a procedure approved in advance by 
the Commissioner; and
    (c) It is demonstrated to the satisfaction of the Commissioner that:
    (1) The grant constitutes a scholarship or fellowship grant which is 
excluded from gross income under section 117(a) and is to be utilized 
for study at an educational institution described in section 151(e) (4);
    (2) The grant constitutes a prize or award which is excluded from 
gross income under section 74(b), and the recipient of such prize or 
award is selected from the general public (within the meaning of section 
4941(d) (2) (G) (i) and the regulations thereunder); or
    (3) The purpose of the grant is to achieve a specific objective, 
produce a report or other similar product, or improve or enhance a 
literary, artistic, musical, scientific, teaching, or other similar 
capacity, skill, or talent of the grantee.


If a grant is made to an individual for a purpose described in section 
4945(g) (3) and such grant otherwise meets the requirements of section 
4945(g), such grant shall not be treated as a taxable expenditure even 
if it is a scholarship or a fellowship grant which is not excludable 
from income under section 117 or if it is a prize or award which is 
includible in income under section 74.
    (iii) Renewals. A renewal of a grant which satisfied the 
requirements of subdivision (ii) of this subparagraph shall not be 
treated as a grant to an individual which is subject to the requirements 
of this section, if:
    (a) The grantor has no information indicating that the original 
grant is being used for any purpose other than that for which it was 
made,
    (b) Any reports due at the time of the renewal decision pursuant to 
the terms of the original grant have been furnished, and
    (c) Any additional criteria and procedures for renewal are objective 
and nondiscriminatory.


For purposes of this section, an extension of the period over which a 
grant is to be paid shall not itself be regarded as a grant or a renewal 
of a grant.
    (4) Certain designated grants--(i) In general. A grant by a private 
foundation to another organization, which the grantee organization uses 
to make payments to an individual for purposes described in section 
4945(d)(3), shall not be regarded as a grant by the private

[[Page 185]]

foundation to the individual grantee if the foundation does not earmark 
the use of the grant for any named individual and there does not exist 
an agreement, oral or written, whereby such grantor foundation may cause 
the selection of the individual grantee by the grantee organization. For 
purposes of this subparagraph, a grant described herein shall not be 
regarded as a grant by the foundation to an individual grantee even 
though such foundation has reason to believe that certain individuals 
would derive benefits from such grant so long as the grantee 
organization exercises control, in fact, over the selection process and 
actually makes the selection completely independently of the private 
foundation.
    (ii) Certain grants to ``public charities''. A grant by a private 
foundation to an organization described in section 509(a) (1), (2), or 
(3), which the grantee organization uses to make payments to an 
individual for purposes described in section 4945(d)(3), shall not be 
regarded as a grant by the private foundation to the individual grantee 
(regardless of the application of subdivision (i) of this subparagraph) 
if the grant is made for a project which is to be undertaken under the 
supervision of the section 509(a) (1), (2), or (3) organization and such 
grantee organization controls the selection of the individual grantee. 
This subdivision shall apply regardless of whether the name of the 
individual grantee was first proposed by the private foundation, but 
only if there is an objective manifestation of the section 509(a), (1), 
(2), or (3) organization's control over the selection process, although 
the selection need not be made completely independently of the private 
foundation. For purposes of this subdivision, an organization shall be 
considered a section 509(a)(1) organization if it is treated as such 
under subparagraph (4) of Sec. 53.4945-5(a).
    (iii) Grants to governmental agencies. If a private foundation makes 
a grant to an organization described in section 170(c)(1) (regardless of 
whether it is described in section 501(c)(3)) and such grant is 
earmarked for use by an individual for purposes described in section 
4945(d)(3), such grant is not subject to the requirements of section 
4945(d)(3) and (g) and this section (regardless of the application of 
subdivision (i) of this subparagraph) if the section 170(c)(1) 
organization satisfies the Commissioner in advance that its grant-making 
program:
    (a) Is in furtherance of a purpose described in section 
170(c)(2)(B),
    (b) Requires that the individual grantee submit reports to it which 
would satisfy paragraph (c)(3) of this section, and
    (c) Requires that the organization investigate jeopardized grants in 
a manner substantially similar to that described in paragraph (c)(4) of 
this section.
    (iv) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. M, a university described in section 170(b)(1)(A)(ii), 
requests that P, a private foundation, grant it $100,000 to enable M to 
obtain the services of a particular scientist for a research project in 
a special field of biochemistry in which he has exceptional 
qualifications and competence. P, after determining that the project 
deserves support, makes the grant to M to enable it to obtain the 
services of this scientist. M is authorized to keep the funds even if it 
is unsuccessful in attempting to employ the scientist. Under these 
circumstances P will not be treated as having made a grant to the 
individual scientist for purposes of section 4945(d)(3) and (g), since 
the requirements of subdivision (i) of this subparagraph have been 
satisfied. Even if M were not authorized to keep the funds if it is 
unsuccessful in attempting to employ the scientist, P would not be 
treated as having made a grant to the individual scientist for purposes 
of section 4945(d)(3) and (g), since it is clear from the facts and 
circumstances that the selection of the particular scientist was made by 
M and thus the requirements of subdivision (ii) of this subparagraph 
would have been satisfied.
    Example 2. Assume the same facts as Example (1), except that there 
are a number of scientists who are qualified to administer the research 
project, P suggests the name of the particular scientist to be employed 
by M, and M is not authorized to keep the funds if it is unsuccessful in 
attempting to employ the particular scientist. For purposes of section 
4945(d)(3) and (g), P will be treated as having made a grant to the 
individual scientist whose name it suggested, since it is clear from the 
facts and circumstances that selection of the particular scientist was 
made by P.
    Example 3. X, a private foundation, is aware of the exceptional 
research facilities at Y University, an organization described in

[[Page 186]]

section 170(b)(1)(A)(ii). Officials of X approach officials of Y with an 
offer to give Y a grant of $100,000 if Y will engage an adequately 
qualified physicist to conduct a specific research project. Y's 
officials accept this proposal, and it is agreed that Y will administer 
the funds. After examining the qualifications of several research 
physicists, the officials of Y agree that A, whose name was first 
suggested by officials of X and who first suggested the specific 
research project to X, is uniquely qualified to conduct the project. X's 
grant letter provides that X has the right to renegotiate the terms of 
the grant if there is a substantial deviation from such terms, such as 
breakdown of Y's research facilities or termination of the conduct of 
the project by an adequately qualified physicist. Under these 
circumstances, X will not be treated as having made a grant to A for 
purposes of section 4945(d)(3) and (g), since the requirements of 
subdivision (ii) of this subparagraph have been satisfied.
    Example 4. Professor A, a scholar employed by University Y, an 
organization described in section 170(b)(1)(A)(ii), approaches 
Foundation X to determine the availability of grant funds for a 
particular research project supervised or conducted by Professor A 
relevant to the program interests of Foundation X. After learning that 
Foundation X would be willing to consider the project if University Y 
were to submit the project to X, Professor A submits his proposal to the 
appropriate administrator of University Y. After making a determination 
that it should assume responsibility for the project, that Professor A 
is qualified to conduct the project, and that his participation would be 
consistent with his other faculty duties, University Y formally adopts 
the grant proposal and submits it to Foundation X. The grant is made to 
University Y which, under the terms of the grant, is responsible for the 
expenditure of the grant funds and the grant project. In such a case, 
and even if Foundation X retains the right to renegotiate the terms of 
the grant if the project ceases to be conducted by Professor A, the 
grant shall not be regarded as a grant by Foundation X to Professor A 
since University Y has retained control over the selection process 
within the meaning of subdivision (ii) of this subparagraph.

    (5) Earmarked grants to individuals. A grant by a private foundation 
to an individual, which meets the requirements of section 4945(d)(3) and 
(g), is a taxable expenditure by such foundation under section 4945(d) 
only if:
    (i) The grant is earmarked to be used for any activity described in 
section 4945(d) (1), (2), or (5), or is earmarked to be used in a manner 
which would violate section 4945(d) (3) or (4),
    (ii) There is an agreement, oral or written, whereby such grantor 
foundation may cause the grantee to engage in any such prohibited 
activity and such grant is in fact used in a manner which violates 
section 4945(d), or
    (iii) The grant is made for a purpose other than a purpose described 
in section 170(c)(2)(B).

For purposes of this subparagraph, a grant by a private foundation is 
earmarked if such grant is given pursuant to an agreement, oral or 
written, that the grant will be used for specific purposes.
    (b) Selection of grantees on ``an objective and nondiscriminatory 
basis''--(1) In general. For purposes of this section, in order for a 
foundation to establish that its grants to individuals are made on an 
objective and nondiscriminatory basis, the grants must be awarded in 
accordance with a program which, if it were a substantial part of the 
foundation's activities, would be consistent with:
    (i) The existence of the foundation's exempt status under section 
501(c)(3);
    (ii) The allowance of deductions to individuals under section 170 
for contributions to the granting foundation; and
    (iii) The requirements of subparagraphs (2), (3), and (4) of this 
paragraph.
    (2) Candidates for grants. Ordinarily, selection of grantees on an 
objective and nondiscriminatory basis requires that the group from which 
grantees are selected be chosen on the basis of criteria reasonably 
related to the purposes of the grant. Furthermore, the group must be 
sufficiently broad so that the giving of grants to members of such group 
would be considered to fulfill a purpose described in section 
170(c)(2)(B). Thus, ordinarily the group must be sufficiently large to 
constitute a charitable class. However, selection from a group is not 
necessary where taking into account the purposes of the grant, one or 
several persons are selected because they are exceptionally qualified to 
carry out these purposes or it is otherwise evident that the selection 
is particularly calculated to effectuate the charitable purpose of the 
grant rather than to benefit particular persons or a particular class of 
persons.

[[Page 187]]

Therefore, consistent with the requirements of this subparagraph, the 
foundation may impose reasonable restrictions on the group of potential 
grantees. For example, selection of a qualified research scientist to 
work on a particular project does not violate the requirements of 
section 4945(d)(3) merely because the foundation selects him from a 
group of three scientists who are experts in that field.
    (3) Selection from within group of potential grantees. The criteria 
used in selecting grant recipients from the potential grantees should be 
related to the purpose of the grant. Thus, for example, proper criteria 
for selecting scholarship recipients might include (but are not limited 
to) the following: Prior academic performance; performance on tests 
designed to measure ability and aptitude for college work; 
recommendations from instructors; financial need; and the conclusions 
which the selection committee might draw from a personal interview as to 
the individual's motivation, character, ability, and potential.
    (4) Persons making selections. The person or group of persons who 
select recipients of grants should not be in a position to derive a 
private benefit, directly or indirectly, if certain potential grantees 
are selected over others.
    (5) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. X company employs 100,000 people of whom 1,000 are 
classified by the company as executives. The company has organized the X 
company foundation which, as its sole activity, provides 100 4-year 
college scholarships per year for children of the company's employees. 
Children of all employees (other than disqualified persons with respect 
to the foundation) who have worked for the X company for at least 2 
years are eligible to apply for these scholarships. In previous years, 
the number of children eligible to apply for such scholarships has 
averaged 2,000 per year. Selection of scholarship recipients from among 
the applicants is made by three prominent educators, who have no 
connection (other than as members of the selection committee) with the 
company, the foundation or any of the employees of the company. The 
selections are made on the basis of the applicants' prior academic 
performance, performance on certain tests designed to measure ability 
and aptitude for college work, and financial need. No disproportionate 
number of scholarships has been granted to relatives of executives of X 
company. Under these circumstances, the operation of the scholarship 
program by the X company foundation: (1) Is consistent with the 
existence of the foundation's exempt status under section 501(c) (3) and 
with the allowance of deductions under section 170 for contributions to 
the foundation; (2) utilizes objective and nondiscriminatory criteria in 
selecting scholarship recipients from among the applicants; and (3) 
utilizes a selection committee which appears likely to make objective 
and nondiscriminatory selections of grant recipients.
    Example 2. Assume the same facts as Example (1), except that the 
foundation establishes a program to provide 20 college scholarships per 
year for members of a certain ethnic minority. All members of this 
minority group (other than disqualified persons with respect to the 
foundation) living in State Z are eligible to apply for these 
scholarships. It is estimated that at least 400 persons will be eligible 
to apply for these scholarships each year. Under these circumstances, 
the operation of this scholarship program by the foundation: (1) Is 
consistent with the existence of the foundation's exempt status under 
section 501(c)(3) and with the allowance of deductions under section 170 
for contributions to the foundation; (2) utilizes objective and 
nondiscriminatory criteria in selecting scholarship recipients from 
among the applicants; and (3) utilizes a selection committee which 
appears likely to make objective and nondiscriminatory selections of 
grant recipients.

    (c) Requirements of a proper procedure--(1) In general. Section 
4945(g) requires that grants to individuals must be made pursuant to a 
procedure approved in advance. To secure such approval, a private 
foundation must demonstrate to the satisfaction of the Commissioner 
that:
    (i) Its grant procedure includes an objective and nondiscriminatory 
selection process (as described in paragraph (b) of this section);
    (ii) Such procedure is reasonably calculated to result in 
performance by grantees of the activities that the grants are intended 
to finance; and
    (iii) The foundation plans to obtain reports to determine whether 
the grantees have performed the activities that the grants are intended 
to finance.

No single procedure or set of procedures is required. Procedures may 
vary depending upon such factors as the size

[[Page 188]]

of the foundation, the amount and purpose of the grants and whether one 
or more recipients are involved.
    (2) Supervision of scholarship and fellowship grants. Except as 
provided in subparagraph (5) of this paragraph, with respect to any 
scholarship or fellowship grants, a private foundation must make 
arrangements to receive a report of the grantee's courses taken (if any) 
and grades received (if any) in each academic period. Such a report must 
be verified by the educational institution attended by the grantee and 
must be obtained at least once a year. In cases of grantees whose study 
at an educational institution does not involve the taking of courses but 
only the preparation of research papers or projects, such as the writing 
of a doctoral thesis, the foundation must receive a brief report on the 
progress of the paper or project at least once a year. Such a report 
must be approved by the faculty member supervising the grantee or by 
another appropriate university official. Upon completion of a grantee's 
study at an educational institution, a final report must also be 
obtained.
    (3) Grants described in section 4945(g)(3). With respect to a grant 
made under section 4945(g)(3), the private foundation shall require 
reports on the use of the funds and the progress made by the grantee 
toward achieving the purposes for which the grant was made. Such reports 
must be made at least once a year. Upon completion of the undertaking 
for which the grant was made, a final report must be made describing the 
grantee's accomplishments with respect to the grant and accounting for 
the funds received under such grant.
    (4) Investigation of jeopardized grants. (i) Where the reports 
submitted under this paragraph or other information (including the 
failure to submit such reports) indicates that all or any part of a 
grant is not being used in furtherance of the purposes of such grant, 
the foundation is under a duty to investigate. While conducting its 
investigation, the foundation must withhold further payments to the 
extent possible until any delinquent reports required by this paragraph 
have been submitted and where required by subdivision (ii) or (iii) of 
this subparagraph.
    (ii) In cases in which the grantor foundation determines that any 
part of a grant has been used for improper purposes and the grantee has 
not previously diverted grant funds to any use not in furtherance of a 
purpose specified in the grant, the foundation will not be treated as 
having made a taxable expenditure solely because of the diversion so 
long as the foundation:
    (a) Is taking all reasonable and appropriate steps either to recover 
the grant funds or to insure the restoration of the diverted funds and 
the dedication (consistent with the requirements of (b) (1) and (2) of 
this subdivision) of other grant funds held by the grantee to the 
purposes being financed by the grant, and
    (b) Withholds any further payments to the grantee after the grantor 
becomes aware that a diversion may have taken place (hereinafter 
referred to as ``further payments'') until it has:
    (1) Received the grantee's assurances that future diversions will 
not occur, and
    (2) Required the grantee to take extraordinary precaution to prevent 
future diversions from occurring.


If a foundation is treated as having made a taxable expenditure under 
this subparagraph in a case to which this subdivision applies, then 
unless the foundation meets the requirements of (a) of this subdivision 
the amount of the taxable expenditure shall be the amount of the 
diversion plus the amount of any further payments to the same grantee. 
However, if the foundation complies with the requirements of (a) of this 
subdivision but not the requirements of (b) of this subdivision, the 
amount of the taxable expenditure shall be the amount of such further 
payments.
    (iii) In cases where a grantee has previously diverted funds 
received from a grantor foundation, and the grantor foundation 
determines that any part of a grant has again been used for improper 
purposes, the foundation will not be treated as having made a taxable 
expenditure solely by reason of such diversion so long as the 
foundation:

[[Page 189]]

    (a) Is taking all reasonable and appropriate steps to recover the 
grant funds or to insure the restoration of the funds and the dedication 
(consistent with the requirements of (b) (2) and (3) of this 
subdivision) of other grant funds held by the grantee to the purposes 
being financed by the grant, and
    (b) Withholds further payments until:
    (1) Such funds are in fact so recovered or restored,
    (2) It has received the grantee's assurances that future diversions 
will not occur, and
    (3) It requires the grantee to take extraordinary precautions to 
prevent future diversions from occurring.


If a foundation is treated as having made a taxable expenditure under 
this subparagraph in a case to which this subdivision applies, then 
unless the foundation meets the requirements of (a) of this subdivision, 
the amount of the taxable expenditure shall be the amount of the 
diversion plus the amount of any further payments to the same grantee. 
However, if the foundation complies with the requirements of (a) of this 
subdivision, but fails to withhold further payments until the 
requirements of (b) of this subdivision are met, the amount of the 
taxable expenditure shall be the amount of such further payments.
    (iv) The phrase ``all reasonable and appropriate steps'' in 
subdivisions (ii) and (iii) of this subparagraph includes legal action 
where appropriate but need not include legal action if such action would 
in all probability not result in the satisfaction of execution on a 
judgment.
    (5) Supervision of certain scholarship and fellowship grants. 
Subparagraphs (2) and (4) of this paragraph shall be considered 
satisfied with respect to scholarship or fellowship grants under the 
following circumstances:
    (i) The scholarship or fellowship grants are described in section 
4945(g) (1);
    (ii) The grantor foundation pays the scholarship or fellowship 
grants to an educational institution described in section 151(e) (4); 
and
    (iii) Such educational institution agrees to use the grant funds to 
defray the recipient's expenses or to pay the funds (or a portion 
thereof) to the recipient only if the recipient is enrolled at such 
educational institution and his standing at such educational institution 
is consistent with the purposes and conditions of the grant.
    (6) Retention of records. A private foundation shall retain records 
pertaining to all grants to individuals for purposes described in 
section 4945(d) (3). Such records shall include:
    (i) All information the foundation secures to evaluate the 
qualification of potential grantees;
    (ii) Identification of grantees (including any relationship of any 
grantee to the foundation sufficient to make such grantee a disqualified 
person of the private foundation within the meaning of section 4946(a) 
(1));
    (iii) Specification of the amount and purpose of each grant; and
    (iv) The follow-up information which the foundation obtains in 
complying with subparagraphs (2), (3), and (4) of this paragraph.
    (7) Example. The provisions of paragraphs (b) and (c) of this 
section may be illustrated by the following example:

    Example. The X foundation grants 10 scholarships each year to 
graduates of high schools in its area to permit the recipients to attend 
college. It makes the availability of its scholarships known by oral or 
written communications each year to the principals of three major high 
schools in the area. The foundation obtains information from each high 
school on the academic qualifications, background, and financial need of 
applicants. It requires that each applicant be recommended by two of his 
teachers or by the principal of his high school. All application forms 
are reviewed by the foundation officer responsible for making the awards 
and scholarships are granted on the basis of the academic qualifications 
and financial need of the grantees. The foundation obtains annual 
reports on the academic performance of the scholarship recipient from 
the college or university which he attends. It maintains a file on each 
scholarship awarded, including the original application, 
recommendations, a record of the action taken on the application, and 
the reports on the recipient from the institution which he attends. The 
described procedures of the X foundation for the making of grants to 
individuals qualify for Internal Revenue Service approval under

[[Page 190]]

section 4945(g). Furthermore, if the X foundation's scholarship program 
meets the requirements of subparagraph (5) of this paragraph, X 
foundation will not have to obtain reports on the academic performance 
of the scholarship recipients.

    (d) Submission of grant procedure--(1) Contents of request for 
approval of grant procedures. A request for advance approval of a 
foundation's grant procedures must fully describe the foundation's 
procedures for awarding grants and for ascertaining that such grants are 
used for the proper purposes. The approval procedure does not 
contemplate specific approval of particular grant programs but instead 
one-time approval of a system of standards, procedures, and follow-up 
designed to result in grants which meet the requirements of section 
4945(g). Thus, such approval shall apply to a subsequent grant program 
as long as the procedures under which it is conducted do not differ 
materially from those described in the request to the Commissioner. The 
request must contain the following items:
    (i) A statement describing the selection process. Such statement 
shall be sufficiently detailed for the Commissioner to determine whether 
the grants are made on an objective and nondiscriminatory basis under 
paragraph (b) of this section.
    (ii) A description of the terms and conditions under which the 
foundation ordinarily makes such grants, which is sufficient to enable 
the Commissioner to determine whether the grants awarded under such 
procedures would meet the requirements of paragraph (1), (2), or (3) of 
section 4945(g).
    (iii) A detailed description of the private foundation's procedure 
for exercising supervision over grants, as described in paragraph (c) 
(2) and (3) of this section.
    (iv) A description of the foundation's procedures for review of 
grantee reports, for investigation where diversion of grant funds from 
their proper purposes is indicated, and for recovery of diverted grant 
funds, as described in paragraph (c) (4) of this section.
    (2) Place of submission. Request for approval of grant procedures 
shall be submitted to the District Director.
    (3) Internal Revenue Service action on request for approval of grant 
procedures. The 45th day after a request for approval of grant 
procedures has been properly submitted to the Internal Revenue Service, 
the organization has not been notified that such procedures are not 
acceptable, such procedures shall be considered as approved from the 
date of submission until receipt of actual notice from the Internal 
Revenue Service that such procedures do not meet the requirements of 
this section. If a grant to an individual for a purpose described in 
section 4945(d) (3) is made after notification to the organization by 
the Internal Revenue Service that the procedures under which the grant 
is made are not acceptable, such grant is a taxable expenditure under 
this section.
    (e) Effective dates--(1) In general. This section shall apply to all 
grants to individuals for travel, study, or other similar purposes which 
are made by private foundations more than 90 days after October 30, 
1972.
    (2) Transitional rules--(i) Grants committed prior to January 1, 
1970. Section 4945(d) (3) and (g) and this section shall not apply to a 
grant for section 170(c) (2) (B) purposes made on or after January 1, 
1970, if the grant was made pursuant to a commitment entered into prior 
to such date, but only if such commitment was made in accordance with 
the foundation's usual practices and is reasonable in amount in light of 
the purposes of the grant. For purposes of this subdivision, a 
commitment will be considered entered into prior to January 1, 1970, if 
prior to such date, the amount and nature of the payments to be made and 
the name of the payee were entered on the records of the payor, or were 
otherwise adequately evidenced, or the notice of the payment to be 
received was communicated to the payee in writing.
    (ii) Grants awarded on or after January 1, 1970. In the case of a 
grant awarded on or after January 1, 1970, but prior to the expiration 
of 90 days after October 30, 1972, and paid within 48 months after the 
award of such grant, the requirements of section 4945(g) that an 
individual grant be awarded on an objective and nondiscriminatory basis 
pursuant to a procedure approved in

[[Page 191]]

advance by the Commissioner will be deemed satisfied if the grantor 
utilizes any procedure in good faith in awarding a grant to an 
individual which, in fact, is reasonably calculated to provide 
objectivity and nondiscrimination in the awarding of such grant and to 
result in a grant which complies with the conditions of section 4945(g) 
(1), (2), or (3).



Sec. 53.4945-5  Grants to organizations.

    (a) Grants to nonpublic organizations--(1) In general. Under section 
4945(d)(4) the term ``taxable expenditure'' includes any amount paid or 
incurred by a private foundation as a grant to an organization (other 
than an organization described in section 509(a) (1), (2) or (3)), 
unless the private foundation exercises expenditure responsibility with 
respect to such grant in accordance with section 4945(h). However, the 
granting foundation does not have to exercise expenditure responsibility 
with respect to amounts granted to organizations described in section 
4945(f).
    (2) ``Grants'' described. For a description of the term ``grants'', 
see Sec. 53.4945-4(a)(2).
    (3) Section 509(a) (1), (2), and (3) organizations. See section 
508(b) and the regulations thereunder for rules relating to when a 
grantor may rely on a potential grantee's characterization of its status 
as set forth in the notice described in section 508(b).
    (4) Certain ``public'' organizations. For purposes of this section, 
an organization will be treated as a section 509(a)(1) organization if:
    (i) It qualifies as such under paragraph (a) of Sec. 1.509(a)-2 of 
this chapter;
    (ii) It is an organization described in section 170(c)(1) or 
511(a)(2)(B), even if it is not described in section 501(c)(3); or
    (iii) It is a foreign government, or any agency or instrumentality 
thereof, or an international organization designated as such by 
Executive order under 22 U.S.C. 288, even if it is not described in 
section 501(c)(3).

However, any grant to an organization referred to in this subparagraph 
must be made exclusively for charitable purposes as described in section 
170(c)(2)(B).
    (5) Certain foreign organizations. If a private foundation makes a 
grant to a foreign organization which does not have a ruling or 
determination letter that it is an organization described in section 
509(a)(1), (2), or (3), such grant will not be treated as a grant made 
to an organization other than an organization described in section 
509(a)(1), (2), or (3) if the grantor private foundation has made a good 
faith determination that the grantee organization is an organization 
described in section 509(a)(1), (2), or (3). Such a ``good faith 
determination'' ordinarily will be considered as made where the 
determination is based on an affidavit of the grantee organization or an 
opinion of counsel (of the grantor or the grantee) that the grantee is 
an organization described in section 509(a)(1), (2), or (3). Such an 
affidavit or opinion must set forth sufficient facts concerning the 
operations and support of the grantee for the Internal Revenue Service 
to determine that the grantee would be likely to qualify as an 
organization described in section 509(a) (1), (2), or (3). See 
paragraphs (b)(5) and (b)(6) of this section for other special rules 
relating to foreign organizations.
    (6) Certain earmarked grants--(i) In general. A grant by a private 
foundation to a grantee organization which the grantee organization uses 
to make payments to another organization (the secondary grantee) shall 
not be regarded as a grant by the private foundation to the secondary 
grantee if the foundation does not earmark the use of the grant for any 
named secondary grantee and there does not exist an agreement, oral or 
written, whereby such grantor foundation may cause the selection of the 
secondary grantee by the organization to which it has given the grant. 
For purposes of this subdivision, a grant described herein shall not be 
regarded as a grant by the foundation to the secondary grantee even 
though such foundation has reason to believe that certain organizations 
would derive benefits from such grant so long as the original grantee 
organization exercises control, in fact, over the selection process and 
actually makes the selection completely independently of the private 
foundation.

[[Page 192]]

    (ii) To governmental agencies. If a private foundation makes a grant 
to an organization described in section 170(c)(1) and such grant is 
earmarked for use by another organization, the granting foundation need 
not exercise expenditure responsibility with respect to such grant if 
the section 170(c)(1) organization satisfies the Commissioner in advance 
that:
    (a) Its grant-making program is in furtherance of a purpose 
described in section 170(c)(2)(B), and
    (b) The section 170(c)(1) organization exercises ``expenditure 
responsibility'' in a manner that would satisfy this section if it 
applied to such section 170(c)(1) organization.


However, with respect to such grant, the granting foundation must make 
the reports required by section 4945(h)(3) and paragraph (d) of this 
section, unless such grant is earmarked for use by an organization 
described in section 509(a) (1), (2), or (3).
    (b) Expenditure responsibility--(1) In general. A private foundation 
is not an insurer of the activity of the organization to which it makes 
a grant. Thus, satisfaction of the requirements of sections 4945(d)(4) 
and (h) and of subparagraph (3) or (4) of this paragraph, will 
ordinarily mean that the grantor foundation will not have violated 
section 4945(d) (1) or (2). A private foundation will be considered to 
be exercising ``expenditure responsibility'' under section 4945(h) as 
long as it exerts all reasonable efforts and establishes adequate 
procedures:
    (i) To see that the grant is spent solely for the purpose for which 
made,
    (ii) To obtain full and complete reports from the grantee on how the 
funds are spent, and
    (iii) To make full and detailed reports with respect to such 
expenditures to the Commissioner.

In cases in which pursuant to paragraph (a)(6) of this section a grant 
is considered made to a secondary grantee rather than the primary 
grantee, the grantor foundation's obligation to obtain reports from the 
grantee pursuant to section 4945(h)(2) and this section will be 
satisfied if appropriate reports are obtained from the secondary 
grantee. For rules relating to expenditure responsibility with respect 
to transfers of assets described in section 507(b)(2), see section 
507(b)(2) and the regulations thereunder.
    (2) Pre-grant inquiry--(i) Before making a grant to an organization 
with respect to which expenditure responsibility must be exercised under 
this section, a private foundation should conduct a limited inquiry 
concerning the potential grantee. Such inquiry should be complete enough 
to give a reasonable man assurance that the grantee will use the grant 
for the proper purposes. The inquiry should concern itself with matters 
such as: (a) The identity, prior history and experience (if any) of the 
grantee organization and its managers; and (b) any knowledge which the 
private foundation has (based on prior experience or otherwise) of, or 
other information which is readily available concerning, the management, 
activities, and practices of the grantee organization. The scope of the 
inquiry might be expected to vary from case to case depending upon the 
size and purpose of the grant, the period over which it is to be paid, 
and the prior experience which the grantor has had with respect to the 
capacity of the grantee to use the grant for the proper purposes. For 
example, if the grantee has made proper use of all prior grants to it by 
the grantor and filed the required reports substantiating such use, no 
further pregrant inquiry will ordinarily be necessary. Similarly, in the 
case of an organization, such as a trust described in section 
4947(a)(2), which is required by the terms of its governing instrument 
to make payments to a specified organization exempt from taxation under 
section 501(a), a less extensive pregrant inquiry is required than in 
the case of a private foundation possessing discretion with respect to 
the distribution of funds.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. Officials of M, a newly established organization which is 
described in section 501(c)(4), request a grant from X foundation to be 
used for a proposed program to combat drug abuse by establishing 
neighborhood clinics in certain ghetto areas of a city. Before making a 
grant to M, X makes an inquiry concerning the identity, prior history 
and experience of the officials of M. X obtains information pertaining 
to the officials

[[Page 193]]

of M from references supplied by these officials. Since one of the 
references indicated that A, an official of M, has an arrest record, 
police records are also checked and A's probation officer is 
interviewed.
    The inquiry also shows M has no previous history of administering 
grants and that the officials of M have had no experience in 
administering programs of this nature. However, in the opinion of X's 
managers, M's officials (including A who appears to be fully 
rehabilitated after having been convicted of a narcotics violation 
several years ago) are well qualified to conduct this program since they 
are members of the communities in which the clinics are to be 
established and are more likely to be trusted by drug users in these 
communities than are outsiders. Under these circumstances X has complied 
with the requirements of this subparagraph and a grant to M for its 
proposed program will not be treated as a taxable expenditure solely 
because of the operation of this subparagraph.
    Example 2. Foundation Y wishes to make a grant to foundation R for 
use in R's scholarship program. Y has made similar grants to R annually 
for the last several years and knows that R's managers have observed the 
terms of the previous grants and have made all requested reports with 
respect to such grants. No changes in R's management have occurred 
during the past several years. Under these circumstances, Y has enough 
information to have such assurance as a reasonable man would require 
that the grant to R will be used for proper purposes. Consequently, Y is 
under no obligation to make any further pregrant inquiry pursuant to 
this subparagraph.
    Example 3. S foundation requests a grant from Z foundation for use 
in S's program of providing medical research fellowships. S has been 
engaged in this program for several years and has received large numbers 
of grants from other foundations. Z's managers know that the reputations 
of S and of S's officials are good. Z's managers also have been advised 
by managers of W foundation that W had recently made a grant to S and 
that W's managers were satisfied that such grant has been used for the 
purposes for which it was made. Under these circumstances Z has enough 
information to have such assurance as a reasonable man would require 
that the grant to S will be used for proper purposes. Consequently, Z is 
under no obligation to make any further pregrant inquiry pursuant to 
this subparagraph.

    (3) Terms of grants. Except as provided in subparagraph (4) of this 
paragraph, in order to meet the expenditure responsibility requirements 
of section 4945(h), a private foundation must require that each grant to 
an organization, with respect to which expenditure responsibility must 
be exercised under this section, be made subject to a written commitment 
signed by an appropriate officer, director, or trustee of the grantee 
organization. Such commitment must include an agreement by the grantee:
    (i) To repay any portion of the amount granted which is not used for 
the purposes of the grant,
    (ii) To submit full and complete annual reports on the manner in 
which the funds are spent and the progress made in accomplishing the 
purposes of the grant, except as provided in paragraph (c)(2) of this 
section,
    (iii) To maintain records of receipts and expenditures and to make 
its books and records available to the grantor at reasonable times, and
    (iv) Not to use any of the funds:
    (a) To carry on propaganda, or otherwise to attempt, to influence 
legislation (within the meaning of section 4945(d)(1)),
    (b) To influence the outcome of any specific public election, or to 
carry on, directly or indirectly, any voter registration drive (within 
the meaning of section 4945(d)(2)),
    (c) To make any grant which does not comply with the requirements of 
section 4945(d) (3) or (4), or
    (d) To undertake any activity for any purpose other than one 
specified in section 170(c)(2)(B).


The agreement must also clearly specify the purposes of the grant. Such 
purposes may include contributing for capital endowment, for the 
purchase of capital equipment, or for general support provided that 
neither the grants nor the income therefrom may be used for purposes 
other than those described in section 170(c)(2)(B).
    (4) Terms of program-related investments. In order to meet the 
expenditure responsibility requirements of section 4945(h), with regard 
to the making of a program-related investment (as defined in section 
4944 and the regulations thereunder), a private foundation must require 
that each such investment with respect to which expenditure 
responsibility must be exercised under section 4945(d)(4) and (h) and 
this section be made subject to a written commitment

[[Page 194]]

signed by an appropriate officer, director, or trustee of the recipient 
organization. Such commitment must specify the purpose of the investment 
and must include an agreement by the organization:
    (i) To use all the funds received from the private foundation (as 
determined under paragraph (c)(3) of this section) only for the purposes 
of the investment and to repay any portion not used for such purposes, 
provided that, with respect to equity investments, such repayment shall 
be made only to the extent permitted by applicable law concerning 
distributions to holders of equity interests,
    (ii) At least once a year during the existence of the program-
related investment, to submit full and complete financial reports of the 
type ordinarily required by commercial investors under similar 
circumstances and a statement that it has complied with the terms of the 
investment,
    (iii) To maintain books and records adequate to provide information 
ordinarily required by commercial investors under similar circumstances 
and to make such books and records available to the private foundation 
at reasonable times, and
    (iv) Not to use any of the funds:
    (a) To carry on propaganda, or otherwise to attempt, to influence 
legislation (within the meaning of section 4945(d)(1)),
    (b) To influence the outcome of any specific public election, or to 
carry on directly or indirectly, and voter registration drive (within 
the meaning of section 4945(d)(2)), or
    (c) With respect to any recipient which is a private foundation (as 
defined in section 509(a)), to make any grant which does not comply with 
the requirements of section 4945 (d) (3) or (4).
    (5) Certain grants to foreign organizations. With respect to a grant 
to a foreign organization (other than an organization described in 
section 509(a) (1), (2), or (3) or treated as so described pursuant to 
paragraph (a)(4) or (a)(5) of this section), subparagraph (3)(iv) or 
(4)(iv) of this paragraph shall be deemed satisfied if the agreement 
referred to in subparagraph (3) or (4) of this paragraph imposes 
restrictions on the use of the grant substantially equivalent to the 
limitations imposed on a domestic private foundation under section 
4945(d). Such restrictions may be phrased in appropriate terms under 
foreign law or custom and ordinarily will be considered sufficient if an 
affidavit or opinion of counsel (of the grantor or grantee) is obtained 
stating that, under foreign law or custom, the agreement imposes 
restrictions on the use of the grant substantially equivalent to the 
restrictions imposed on a domestic private foundation under subparagraph 
(3) or (4) of this paragraph.
    (6) Special rules for grants by foreign private foundations. With 
respect to activities in jurisdictions other than those described in 
section 170(c)(2)(A), the failure of a foreign private foundation which 
is described in section 4948(b) to comply with subparagraph (3) or (4) 
of this paragraph with respect to a grant to an organization shall not 
constitute an act or failure to act which is a prohibited transaction 
(within the meaning of section 4948(c)(2)).
    (7) Expenditure responsibility with respect to certain transfers of 
assets described in section 507--(i) Transfers of assets described in 
section 507(b)(2). For rules relating to the extent to which the 
expenditure responsibility rules contained in section 4945 (d)(4) and 
(h) and this section apply to transfers of assets described in section 
507(b)(2), see Sec. Sec. 1.507-3(a)(7), 1.507-3 (a)(8)(ii)(f), and 
1.507-3(a)(9) of this chapter.
    (ii) Certain other transfers of assets. For rules relating to the 
extent to which the expenditure responsibility rules contained in 
section 4945 (d)(4) and (h) and this section apply to certain other 
transfers of assets described in Sec. 1.507-3(b) of this chapter, see 
Sec. 1.507-3(b) of this chapter.
    (8) Restrictions on grants (other than program-related investments) 
to organizations not described in section 501(c)(3). For other 
restrictions on certain grants (other than program-related investments) 
to organizations which are not described in section 501(c)(3), see Sec. 
53.4945-6(c).
    (c) Reports from grantees--(1) In general. In the case of grants 
described in section 4945(d)(4), except as provided in subparagraph (2) 
of this paragraph, the

[[Page 195]]

granting private foundation shall require reports on the use of the 
funds, compliance with the terms of the grant, and the progress made by 
the grantee toward achieving the purposes for which the grant was made. 
The grantee shall make such reports as of the end of its annual 
accounting period within which the grant or any portion thereof is 
received and all such subsequent periods until the grant funds are 
expended in full or the period of the grantee for which such reports 
shall be furnished to the grantor within a reasonable period of time 
after the close of the annual accounting period of the grantee for which 
such reports are made. Within a reasonable period of time after the 
close of its annual accounting period during which the use of the grant 
funds is completed, the grantee must make a final report with respect to 
all expenditures made from such funds (including salaries, travel, and 
supplies), and indicating the progress made toward the goals of the 
grant. The grantor need not conduct any independent verification of such 
reports unless it has reason to doubt their accuracy or reliability.
    (2) Capital endowment grants to exempt private foundations. If a 
private foundation makes a grant described in section 4945(d)(4) to a 
private foundation which is exempt from taxation under section 501(a) 
for endowment, for the purchase of capital equipment, or for other 
capital purposes, the grantor foundation shall require reports from the 
grantee on the use of the principal and the income (if any) from the 
grant funds. The grantee shall make such reports annually for its 
taxable year in which the grant was made and the immediately succeeding 
2 taxable years. Only if it is reasonably apparent to the grantor that, 
before the end of such second succeeding taxable year, neither the 
principal, the income from the grant funds, nor the equipment purchased 
with the grant funds has been used for any purpose which would result in 
liability for tax under section 4945(d), the grantor may then allow such 
reports to be discontinued.
    (3) Grantees' accounting and recordkeeping procedures. (i) A private 
foundation grantee exempt from taxation under section 501(a) (or the 
recipient of a program-related investment) need not segregate grant 
funds physically nor separately account for such funds on its books 
unless the grantor requires such treatment of the grant funds. If such a 
grantee neither physically segregates grant funds nor establishes 
separate accounts on its books, grants received within a given taxable 
year beginning after December 31, 1969, shall be deemed, for purposes of 
section 4945, to be expended before grants received in a succeeding 
taxable year. In such case expenditures of grants received within any 
such taxable year shall be prorated among all such grants.

In accounting for grant expenditures, private foundations may make the 
necessary computations on a cumulative annual basis (or, where 
appropriate, as of the date for which the computations are made). The 
rules set forth in the preceding three sentences shall apply to the 
extent they are consistent with the available records of the grantee and 
with the grantee's treatment of qualifying distributions under section 
4942(h) and the regulations thereunder. The records of expenditures, as 
well as copies of the reports submitted to the grantor, must be kept for 
at least 4 years after completion of the use of the grant funds.
    (ii) For rules relating to accounting and recordkeeping requirements 
for grantees other than those described in subdivision (i) of this 
subparagraph, see Sec. Sec. 53.4945-5(b)(8) and 53.4945-6(c).
    (4) Reliance on information supplied by grantee. A private 
foundation exercising expenditure responsibility with respect to its 
grants may rely on adequate records or other sufficient evidence 
supplied by the grantee organization (such as a statement by an 
appropriate officer, director or trustee of such grantee organization) 
showing, to the extent applicable, the information which the grantor 
must report to the Internal Revenue Service in accordance with paragraph 
(d)(2) of this section.
    (d) Reporting to Internal Revenue Service by grantor--(1) In 
general. To satisfy the reportmaking requirements of section 4945(h)(3), 
a granting foundation must provide the required information

[[Page 196]]

on its annual information return, required to be filed by section 6033, 
for each taxable year with respect to each grant made during the taxable 
year which is subject to the expenditure responsibility requirements of 
section 4945(h). Such information must also be provided on such return 
with respect to each grant subject to such requirements upon which any 
amount or any report is outstanding at any time during the taxable year. 
However, with respect to any grant made for endowment or other capital 
purposes, the grantor must provide the required information only for any 
taxable year for which the grantor must require a report from the 
grantee under paragraph (c)(2) of this section. The requirements of this 
subparagraph with respect to any grant may be satisfied by submission 
with the foundation's information return of a report received from the 
grantee, if the information required by subparagraph (2) of this 
paragraph is contained in such report.
    (2) Contents of report. The report required by this paragraph shall 
include the following information:
    (i) The name and address of the grantee.
    (ii) The date and amount of the grant.
    (iii) The purpose of the grant.
    (iv) The amounts expended by the grantee (based upon the most recent 
report received from the grantee).
    (v) Whether the grantee has diverted any portion of the funds (or 
the income therefrom in the case of an endowment grant) from the purpose 
of the grant (to the knowledge of the grantor).
    (vi) The dates of any reports received from the grantee.
    (vii) The date and results of any verification of the grantee's 
reports undertaken pursuant to and to the extent required under 
paragraph (c)(1) of this section by the grantor or by others at the 
direction of the grantor.
    (3) Recordkeeping requirements. In addition to the information 
included on the information return, a granting foundation shall make 
available to the Internal Revenue Service at the foundation's principal 
office each of the following items:
    (i) A copy of the agreement covering each ``expenditure 
responsibility'' grant made during the taxable year.
    (ii) A copy of each report received during the taxable year from 
each grantee on any ``expenditure responsibility'' grant, and
    (iii) A copy of each report made by the grantor's personnel or 
independent auditors of any audits or other investigations made during 
the taxable year with respect to any ``expenditure responsibility'' 
grant.
    (4) Reports received after the close of grantor's accounting year. 
Data contained in reports required by this paragraph, which reports are 
received by a private foundation after the close of its accounting year 
but before the due date of its information return for that year, need 
not be reported on such return, but may be reported on the grantor's 
information return for the year in which such reports are received from 
the grantee.
    (e) Violations of expenditure responsibility requirements--(1) 
Diversions by grantee. (i) Any diversion of grant funds (including the 
income therefrom in the case of an endowment grant) by the grantee to 
any use not in furtherance of a purpose specified in the grant may 
result in the diverted portion of such grant being treated as a taxable 
expenditure of the grantor under section 4945(d)(4). However, for 
purposes of this section, the fact that a grantee does not use any 
portion of the grant funds as indicated in the original budget 
projection shall not be treated as a diversion if the use to which the 
funds are committed is consistent with the purpose of the grant as 
stated in the grant agreement and does not result in a violation of the 
terms of such agreement required to be included by paragraph (b)(3) or 
(b)(4) of this section.
    (ii) In any event, a grantor will not be treated as having made a 
taxable expenditure under section 4945(d)(4) solely by reason of a 
diversion by the grantee, if the grantor has complied with subdivision 
(iii) (a) and (b) or (iv) (a) and (b) of this subparagraph, whichever is 
applicable.
    (iii) In cases in which the grantor foundation determines that any 
part of

[[Page 197]]

a grant has been used for improper purposes and the grantee has not 
previously diverted grant funds, the foundation will not be treated as 
having made a taxable expenditure solely by reason of the diversion so 
long as the foundation:
    (a) Is taking all reasonable and appropriate steps either to recover 
the grant funds or to insure the restoration of the diverted funds and 
the dedication (consistent with the requirements of (b) (1) and (2) of 
this subdivision) of the other grant funds held by the grantee to the 
purposes being financed by the grant, and
    (b) Withholds any further payments to the grantee after the grantor 
becomes aware that a diversion may have taken place (hereinafter 
referred to as ``further payments'') until it has:
    (1) Received the grantee's assurances that future diversions will 
not occur, and
    (2) Required the grantee to take extraordinary precautions to 
prevent future diversions from occurring.


If a foundation is treated as having made a taxable expenditure under 
this subparagraph in a case to which this subdivision applies, then 
unless the foundation meets the requirements of (a) of this subdivision 
the amount of the taxable expenditure shall be the amount of the 
diversion (for example, the income diverted in the case of an endowment 
grant, or the rental value of capital equipment for the period of time 
for which diverted) plus the amount of any further payments to the same 
grantee. However, if the foundation complies with the requirements of 
(a) of this subdivision but not the requirements of (b) of this 
subdivision, the amount of the taxable expenditure shall be the amount 
of such further payments.
    (iv) In cases where a grantee has previously diverted funds received 
from a grantor foundation, and the grantor foundation determines that 
any part of a grant has again been used for improper purposes, the 
foundation will not be treated as having made a taxable expenditure 
solely by reason of such diversion so long as the foundation:
    (a) Is taking all reasonable and appropriate steps to recover the 
grant funds or to insure the restoration of the diverted funds and the 
dedication (consistent with the requirements of (b) (2) and (3) of this 
subdivision) of other grant funds held by the grantee to the purposes 
being financed by the grant, except that if, in fact, some or all of the 
diverted funds are not so restored or recovered, then the foundation 
must take all reasonable and appropriate steps to recover all of the 
grant funds, and
    (b) Withholds further payments until:
    (1) Such funds are in fact so recovered or restored,
    (2) It has received the grantee's assurances that future diversions 
will not occur, and
    (3) It requires the grantee to take extraordinary precautions to 
prevent future diversions from occurring.


If a foundation is treated as having made a taxable expenditure under 
this subparagraph in a case to which this subdivision applies, then 
unless the foundation meets the requirements of (a) of this subdivision, 
the amount of the taxable expenditure shall be the amount of the 
diversion plus the amount of any further payments to the same grantee. 
However, if the foundation complies with the requirements of (a) of this 
subdivision, but fails to withhold further payments until the 
requirements of (b) of this subdivision are met, the amount of the 
taxable expenditure shall be the amount of such further payments.
    (v) The phrase ``all reasonable and appropriate steps'' (as used in 
subdivisions (iii) and (iv) of this subparagraph) includes legal action 
where appropriate but need not include legal action if such action would 
in all probability not result in the satisfaction of execution on a 
judgment.
    (2) Grantee's failure to make reports. A failure by the grantee to 
make the reports required by paragraph (c) of this section (or the 
making of inadequate reports) shall result in the grant's being treated 
as a taxable expenditure by the grantor unless the grantor:
    (i) Has made the grant in accordance with paragraph (b) of this 
section,
    (ii) Has complied with the reporting requirements contained in 
paragraph (d) of this section,

[[Page 198]]

    (iii) Makes a reasonable effort to obtain the required report, and
    (iv) Withholds all future payments on this grant and on any other 
grant to the same grantee until such report is furnished.
    (3) Violations by the grantor. In addition to the situations 
described in subparagraphs (1) and (2) of this paragraph, a grant which 
is subject to the expenditure responsibility requirements of section 
4945(h) will be considered a taxable expenditure of the granting 
foundation if the grantor:
    (i) Fails to make a pregrant inquiry as described in paragraph 
(b)(2) of this section,
    (ii) Fails to make the grant in accordance with a procedure 
consistent with the requirements of paragraph (b) (3) or (4) of this 
section, or
    (iii) Fails to report to the Internal Revenue Service as provided in 
paragraph (d) of this section.
    (f) Effective dates--(1) In general. This section shall apply to all 
grants which are subject to the expenditure responsibility requirements 
of section 4945(d)(4) and (h) and which are made by private foundations 
more than 90 days after October 30, 1972.
    (2) Transitional rules--(i) Certain grants awarded prior to May 27, 
1969. Section 4945(d)(4) and (h) and this section shall not apply to a 
grant to a private foundation which is not controlled, directly or 
indirectly, by the grantor foundation or one or more disqualified 
persons (as defined in section 4946) with respect to the grantor 
foundation, provided that such grant:
    (a) Is made pursuant to a written commitment which was binding on 
May 26, 1969, and at all times thereafter,
    (b) Is made for one or more of the purposes described in section 
170(c)(2)(B), and
    (c) Is to be paid out to such grantee foundation on or before 
December 31, 1974.
    (ii) Grants or expenditures committed prior to January 1, 1970. 
Except as provided in paragraph (e)(2)(i) of Sec. 53.4945-4, section 
4945 shall not apply to a grant or an expenditure for section 
170(c)(2)(B) purposes made on or after January 1, 1970, if the grant or 
expenditure was made pursuant to a commitment entered into prior to such 
date, but only if (in the case of a grant or an expenditure other than 
an unlimited general-purpose grant to an organization) such commitment 
is reasonable in amount in light of the purposes of the grant. For 
purposes of this subdivision, a commitment will be considered entered 
into prior to January 1, 1970, if prior to such date, the amount and 
nature of the payments to be made and the name of the payee were entered 
on the records of the payor, or were otherwise adequately evidenced, or 
the notice of the payment to be received was communicated to the payee 
in writing.
    (iii) Grants awarded on or after January 1, 1970. Paragraphs (b), 
(c), and (d) of this section shall not apply to grants awarded on or 
after January 1, 1970, but prior to the expiration of 90 days after 
October 30, 1972, if the grantor has made reasonable efforts, and has 
established adequate procedures such as a prudent man would adopt in 
managing his own property, to see that the grant is spent solely for the 
purpose for which made, to obtain full and complete reports from the 
grantee on how the funds are spent, and to make full and detailed 
reports with respect to such grant to the Commissioner. With respect to 
any return filed with the Internal Revenue Service before the expiration 
of 90 days after October 30, 1972, the grantor may treat reports which 
satisfy the requirements of the statement to be attached to Form 4720 
for the year 1970 under ``Specific Instructions--Question B'' (items (1) 
through (5)) as satisfying the grantor reporting requirements with 
respect to ``expenditure responsibility'' grants. In the case of a 
private foundation required to file an annual return for a taxable year 
ending after January 1, 1970, and before December 31, 1970, the 
reporting requirements imposed by section 4945(h)(3) for such period 
shall be regarded as satisfied if such reports are made on the annual 
return for its first taxable year beginning after December 31, 1969.

[T.D. 7215, 37 FR 23161, Oct. 31, 1972; 37 FR 23918, Nov. 10, 1972, as 
amended by T.D. 7233, 37 FR 28162, Dec. 21, 1972; T.D. 7290, 38 FR 
31834, Nov. 19, 1973]

[[Page 199]]



Sec. 53.4945-6  Expenditures for noncharitable purposes.

    (a) In general. Under section 4945(d)(5) the term ``taxable 
expenditure'' includes any amount paid or incurred by a private 
foundation for any purpose other than one specified in section 
170(c)(2)(B). Thus, ordinarily only an expenditure for an activity 
which, if it were a substantial part of the organization's total 
activities, would cause loss of tax exemption is a taxable expenditure 
under section 4945(d)(5). For purposes of this section and Sec. Sec. 
53.4945-1 through 53.4945-5, the term ``purposes described in section 
170(c)(2)(B)'' shall be treated as including purposes described in 
section 170(c)(2)(B) whether or not carried out by an organization 
described in section 170(c).
    (b) Particular expenditures. (1) The following types of expenditures 
ordinarily will not be treated as taxable expenditures under section 
4945(d)(5):
    (i) Expenditures to acquire investments entered into for the purpose 
of obtaining income or funds to be used in furtherance of purposes 
described in section 170(c)(2)(B),
    (ii) Reasonable expenses with respect to investments described in 
subdivision (i) of this subparagraph,
    (iii) Payment of taxes,
    (iv) Any expenses which qualify as deductions in the computation of 
unrelated business income tax under section 511,
    (v) Any payment which constitutes a qualifying distribution under 
section 4942(g) or an allowable deduction under section 4940,
    (vi) Reasonable expenditures to evaluate, acquire, modify, and 
dispose of program-related investments, or
    (vii) Business expenditures by the recipient of a program-related 
investment.
    (2) Conversely, any expenditures for unreasonable administrative 
expenses, including compensation, consultant fees, and other fees for 
services rendered, will ordinarily be taxable expenditures under section 
4945(d)(5) unless the foundation can demonstrate that such expenses were 
paid or incurred in the good faith belief that they were reasonable and 
that the payment or incurrence of such expenses in such amounts was 
consistent with ordinary business care and prudence. The determination 
whether an expenditure is unreasonable shall depend upon the facts and 
circumstances of the particular case.
    (c) Grants to ``noncharitable'' organizations--(1) In general. Since 
a private foundation cannot make an expenditure for a purpose other than 
a purpose described in section 170(c)(2)(B), a private foundation may 
not make a grant to an organization other than an organization described 
in section 501(c)(3) unless
    (i) The making of the grant itself constitutes a direct charitable 
act or the making of a program-related investment, or
    (ii) Through compliance with the requirements of subparagraph (2) of 
this paragraph, the grantor is reasonably assured that the grant will be 
used exclusively for purposes described in section 170(c)(2)(B).

For purposes of this paragraph, an organization treated as a section 
509(a)(1) organization under Sec. 53.4945-5(a)(4) shall be treated as 
an organization described in section 501(c)(3).
    (2) Grants other than transfers of assets described in Sec. 1.507-
3(c)(1). (i) If a private foundation makes a grant which is not a 
transfer of assets pursuant to any liquidation, merger, redemption, 
recapitalization, or other adjustment, organization or reorganization to 
any organization (other than an organization described in section 
501(c)(3) except an organization described in section 509(a)(4)), the 
grantor is reasonably assured (within the meaning of subparagraph 
(1)(ii) of this paragraph) that the grant will be used exclusively for 
purposes described in section 170(c)(2)(B) only if the grantee 
organization agrees to maintain and, during the period in which any 
portion of such grant funds remain unexpended, does continuously 
maintain the grant funds (or other assets transferred) in a separate 
fund dedicated to one or more purposes described in section 
170(c)(2)(B). The grantor of a grant described in this paragraph must 
also comply with the expenditure responsibility provisions contained in 
sections 4945(d) and (h) and Sec. 53.4945-5.
    (ii) For purposes of this paragraph, a foreign organization which 
does not

[[Page 200]]

have a ruling or determination letter that it is an organization 
described in section 501(c)(3) (other than section 509(a)(4)) will be 
treated as an organization described in section 501(c)(3) (other than 
section 509(a)(4)) if in the reasonable judgment of a foundation manager 
of the transferor private foundation, the grantee organization is an 
organization described in section 501(c)(3) (other than section 
509(a)(4)). The term ``reasonable judgment'' shall be given its 
generally accepted legal sense within the outlines developed by judicial 
decisions in the law of trusts.
    (3) Transfers of assets described in Sec. 1.507-3(c)(1). If a 
private foundation makes a transfer of assets (other than a transfer 
described in subparagraph (1)(i) of this paragraph) pursuant to any 
liquidation, merger, redemption, recapitalization, or other adjustment, 
organization, or reorganization to any person, the transferred assets 
will not be considered used exclusively for purposes described in 
section 170(c)(2)(B) unless the assets are transferred to a fund or 
organization described in section 501(c)(3) (other than an organization 
described in section 509(a)(4)) or treated as so described under section 
4947(a)(1).

[T.D. 7215, 37 FR 23161, Oct. 31, 1972, as amended by T.D. 7233, 37 FR 
28162, Dec. 21, 1972]



                 Subpart G_Definitions and Special Rules



Sec. 53.4946-1  Definitions and special rules.

    (a) Disqualified person. (1) For purposes of Chapter 42 and the 
regulations thereunder, the following are disqualified persons with 
respect to a private foundation:
    (i) All substantial contributors to the foundation, as defined in 
section 507 (d)(2) and the regulations thereunder.
    (ii) All foundation managers of the foundation as defined in section 
4946 (b)(1) and paragraph (f)(1)(i) of this section,
    (iii) An owner of more than 20 percent of:
    (a) The total combined voting power of a corporation,
    (b) The profits interest of a partnership,
    (c) The beneficial interest of a trust or unincorporated enterprise.

which is (during such ownership) a substantial contributor to the 
foundation, as defined in section 507(d)(2) and the regulations 
thereunder,
    (iv) A member of the family, as defined in section 4946(d) and 
paragraph (h) of this section, of any of the individuals described in 
subdivision (i), (ii), or (iii) of this subparagraph,
    (v) A corporation of which more than 35 percent of the total 
combined voting power is owned by persons described in subdivision (i), 
(ii), (iii), or (iv) of this subparagraph,
    (vi) A partnership of which more than 35 percent of the profits 
interest is owned by persons described in subdivision (i), (ii), (iii), 
or (iv) of this subparagraph, and
    (vii) A trust, estate, or unincorporated enterprise of which more 
than 35 percent of the beneficial interest is owned by persons described 
in subdivision (i), (ii), (iii), or (iv) of this subparagraph.
    (2) For purposes of subparagraphs (1)(iii) (b) and (vi) of this 
paragraph, the profits interest of a partner shall be equal to his 
distributive share of income of the partnership, as determined under 
section 707(b)(3) and the regulations thereunder as modified by section 
4946(a)(4).
    (3) For purposes of subparagraph (1) (iii)(c) and (vii) of this 
paragraph, the beneficial interest in an unincorporated enterprise 
(other than a trust or estate) includes any right to receive a portion 
of distributions from profits of such enterprise, and, if the portion of 
distributions is not fixed by an agreement among the participants, any 
right to receive a portion of the assets (if any) upon liquidation of 
the enterprise, except as a creditor or employee. For purposes of this 
subparagraph, a right to receive distributions of profits includes a 
right to receive any amount from such profits other than as a creditor 
or employee, whether as a sum certain or as a portion of profits 
realized by the enterprise. Where there is no agreement fixing the 
rights of the participants in such enterprise, the fraction of the 
respective interests of each participant in such enterprise shall be 
determined by dividing the amount of

[[Page 201]]

all investments or contributions to the capital of the enterprise made 
or obligated to be made by such participant by the amount of all 
investments or contributions to capital made or obligated to be made by 
all of them.
    (4) For purposes of subparagraph (1) (iii) (c) and (vii) of this 
paragraph, a person's beneficial interest in a trust shall be determined 
in proportion to the actuarial interest of such person in the trust.
    (5) For purposes of subparagraph (1) (iii) (a) and (v) of this 
paragraph, the term ``combined voting power'' includes voting power 
represented by holdings of voting stock, actual or constructive (under 
section 4946(a)(3)), but does not include voting rights held only as a 
director or trustee.
    (6) For purposes of subparagraph (1) (iii) (a) and (v) of this 
paragraph, the term ``voting power'' includes outstanding voting power 
and does not include voting power obtainable but not obtained, such as, 
for example, voting power obtainable by converting securities or 
nonvoting stock into voting stock or by exercising warrants or options 
to obtain voting stock, and voting power which will vest in preferred 
stockholders only if and when the corporation has failed to pay 
preferred dividends for a specified period of time or has otherwise 
failed to meet specified requirements. Similarly, for purposes of 
subparagraph (1)(iii) (b) and (c), (vi), and (vii) of this paragraph, 
the terms ``profits interest'' and ``beneficial interest'' include any 
such interest that is outstanding, but do not include any such interest 
that is obtainable but has not been obtained.
    (7) For purposes of sections 170(b) (1)(E)(iii), 507(d)(1), 508(d), 
509(a) (1) and (3), and Chapter 42, the term ``disqualified person'' 
shall not include an organization which is described in section 509(a) 
(1), (2), or (3), or any other organization which is wholly owned by 
such section 509(a) (1), (2), or (3) organization.
    (8) For purposes of section 4941 only, the term ``disqualified 
person'' shall not include any organization which is described in 
section 501(c)(3) (other than an organization described in section 
509(a)(4)).
    (b) Section 4943. (1) For purposes of section 4943 only, the term 
``disqualified person'' includes a private foundation:
    (i) Which is effectively controlled (within the meaning of Sec. 
1.482-1(a)(3) of this chapter), directly or indirectly, by the same 
person or persons (other than a bank, trust company, or similar 
organization acting only as a foundation manager) who control the 
private foundation in question, or
    (ii) Substantially all the contributions to which were made, 
directly or indirectly, by persons described in subdivision (i), (ii), 
(iii), or (iv) of paragraph (a)(1) of this section who made, directly or 
indirectly, substantially all of the contributions to the private 
foundation in question.
    (2) For purposes of subparagraph (1)(ii) of this paragraph, one or 
more persons will be considered to have made substantially all of the 
contributions to a private foundation, if such persons have contributed 
or bequeathed at least 85 percent (and each such person has contributed 
or bequeathed at least 2 percent) of the total contributions and 
bequests (within the meaning of section 507(d)(2) and the regulations 
thereunder) which have been received by such private foundation during 
its entire existence.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. A, a private foundation, has a board of directors made up 
of X, Y, Z, M, N, and O. Foundation B's board of directors is made up of 
Y, M, N, and O. The board of directors in each case has plenary power to 
determine the manner in which the foundation is operated. For purposes 
of section 4943, foundation A is a disqualified person with respect to 
foundation B, and foundation B, is a disqualified person with respect to 
foundation A.
    Example 2. Private foundation A has received contributions of 
$100,000 throughout its existence: $35,000 from X, $51,000 from Y (who 
is X's father), and $14,000 from Z (an unrelated person). Private 
foundation B has received $100,000 in contributions during its 
existence: $50,000 from X and $50,000 from W, X's wife.


For purposes of section 4943, private foundation A is a disqualified 
person with respect to private foundation B, and private foundation B is 
a disqualified person with respect to private foundation A.


[[Page 202]]


    (c) Section 4941. For purposes of section 4941, a government 
official, as defined in section 4946(c) and paragraph (g) of this 
section, is a disqualified person.
    (d) Attribution of stockholdings. (1) For purposes of paragraph 
(a)(1)(iii) (a) and (v) of this section, indirect stockholdings shall be 
taken into account under section 267(c) and the regulations thereunder. 
However, for purposes of this paragraph:
    (i) Section 267(c)(4) shall be treated as though it provided that 
the members of the family of an individual are the members within the 
meaning of section 4946(d) and paragraph (h) of this section; and
    (ii) Any stockholdings which have been counted once (whether by 
reason of actual or constructive ownership) in applying section 
4946(a)(1)(E) shall not be counted a second time.

For purposes of paragraph (a)(1)(v) or this section, section 267(c) 
shall be applied without regard to section 267(c)(3), and stock 
constructively owned by an individual by reason of the application of 
section 267(c)(2) shall not be treated as owned by him if he is 
described in section 4946(a)(1)(D) but not also in section 4946(a)(1) 
(A), (B), or (C).
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. D is a substantial contributor to private foundation Y. D 
owns 20 percent of the outstanding stock of corporation P. E, D's wife, 
owns none of the outstanding stock of P. F, E's father, owns 10 percent 
of the outstanding stock of P. E is treated under section 507(d)(2) as a 
substantial contributor to Y. E is also treated under section 267(c)(2) 
as owning both D's 20 percent and F's 10 percent of P, but E is treated 
as owning nothing for purposes of section 4946(a)(1)(E) because D's 20 
percent and F's 10 percent have already been taken into account once 
(because of their actual ownership of the stock of P) for such purposes. 
Hence, corporation P is not a disqualified person under section 
4946(a)(1)(E) with respect to private foundation Y because persons 
described in section 4946(a)(1) (A), (B), (C), and (D) own only 30 
percent of the stock of P.
    Example 2. I, a substantial contributor to private foundation X, is 
the son of J. I owns 100 percent of the stock of corporation R, which in 
turn owns 18 percent of the stock of corporation S. J owns 18 percent of 
the stock of S. I constructively owns 36 percent of the stock of S (J's 
18 percent plus R's 18 percent). Both J's actual holdings and R's actual 
holdings are counted in determining I's constructive holdings because 
this does not result in counting either of the holdings more than once 
for purposes of section 4946 (a)(1)(E). Therefore, S is a disqualified 
person with respect to private foundation X, since I, a substantial 
contributor, constructively owns more than 35 percent of S's stock.

    (e) Attribution of profits or beneficial interests. (1) For purposes 
of paragraph (a) (1) (iii) (b), (iii) (c) (vi), and (vii) of this 
section, ownership of profits or beneficial interests shall be taken 
into account as though such ownership related to stockholdings, if such 
stockholdings would be taken into account under section 267(c) and the 
regulations thereunder, except that section 267(c)(3) shall not apply to 
attribute the ownership of one partner to another solely by reason of 
such partner relationship. However, for purposes of this paragraph:
    (i) Section 267(c)(4) shall be treated as though it provided that 
the members of the family of an individual are the members within the 
meaning of section 4946(d) and paragraph (h) of this section; and
    (ii) Any profits interest or beneficial interest which has been 
counted once (whether by reason of actual or constructive ownership) in 
applying section 4946(a)(1) (F) or (G) shall not be counted a second 
time.

For purposes of paragraph (a)(1) (vi) and (vii) of this section, profits 
or beneficial interests constructively owned by an individual by reason 
of the application of section 267(c)(2) shall not be treated as owned by 
him if he is described in section 4946(a)(1)(D) but not in section 
4946(a)(1)(A), (B) or (C).
    (2) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. Partnership S is a substantial contributor to private 
foundation X. Trust T, of which G is sole beneficiary, owns 12 percent 
of the profits interest of S. G's husband, H, owns 10 percent of the 
profits interest of S. H is a disqualified person with respect to X 
(under section 4946(a)(1)(C)) because he is considered to own 22 percent 
of the profits interest of S (10 percent actual ownership, plus G's 12 
percent constructively under section 267(c)(2)). G is a disqualified 
person with

[[Page 203]]

respect to X (under section 4946(a)(1)(C) because she is considered to 
own 22 percent of the profits interest of S (12 percent constructively 
by reason of her beneficial interest in trust T, plus 10 percent 
constructively under section 267(c)(2) by reason of being a member of 
the family of H).

    (f) Foundation manager. (1) For purposes of Chapter 42 and the 
regulations thereunder, the term ``foundation manager'' means:
    (i) An officer, director, or trustee of a foundation (or a person 
having powers or responsibilities similar to those of officers, 
directors, or trustees of the foundation), and
    (ii) With respect to any act or failure to act, any employee of the 
foundation having final authority or responsibility (either officially 
or effectively) with respect to such act or failure to act.
    (2) For purposes of subparagraph (1)(i) of this paragraph, a person 
shall be considered an officer of a foundation if:
    (i) He is specifically so designated under the certificate of 
incorporation, bylaws, or other constitutive documents of the 
foundation; or
    (ii) He regularly exercises general authority to make administrative 
or policy decisions on behalf of the foundation.

With respect to any act or failure to act, any person described in 
subdivision (ii) of this subparagraph who has authority merely to 
recommend particular administrative or policy decisions, but not to 
implement them without approval of a superior, is not an officer. 
Moreover, such independent contractors as attorneys, accountants, and 
investment managers and advisers, acting in their capacities as such, 
are not officers within the meaning of subparagraph (1)(i) of this 
paragraph.
    (3) For purposes of subparagraph (1)(ii) of this paragraph, an 
individual rendering services to a private foundation shall be 
considered an employee of the foundation only if he is an employee 
within the meaning of section 3121(d)(2).
    (4) Since the definition of the term ``disqualified person'' 
contained in section 4946(a)(1)(B) incorporates only so much of the 
definition of the term ``foundation manager'' as is found in section 
4946(b)(1) and subparagraph (1)(i) of this paragraph, any references, in 
section 4946 and this section, to ``disqualified persons'' do not 
constitute references to persons who are ``foundation managers'' solely 
by reason of the definition of that term contained in section 4946(b)(2) 
and subparagraph (1)(ii) of this paragraph.
    (g) Government official--(1) In general. Except as provided in 
subparagraph (3) of this paragraph, for purposes of section 4941 and 
paragraph (c) of this section, the term ``government official'' means, 
with respect to an act of selfdealing described in section 4941, an 
individual who, at the time of such act, is described in subdivision 
(i), (ii), (iii), (iv), or (v) of this subparagraph (other than a 
``special Government employee'' as defined in 18 U.S.C. 202(a)):
    (i)(a) An individual who holds an elective public office in the 
executive or legislative branch of the Government of the United States.
    (b) An individual who holds an office in the executive or judicial 
branch of the Government of the United States, appointment to which was 
made by the President.
    (ii) An individual who holds a position in the executive, 
legislative or judicial branch of the Government of the United States:
    (a) Which is listed in schedule C of rule VI of the Civil Service 
Rules, or
    (b) The compensation for which is equal to or greater than the 
lowest rate prescribed for GS-16 of the General Schedule under 5 U.S.C. 
5332.
    (iii) An individual who holds a position under the House of 
Representatives or the Senate of the United States, as an employee of 
either of such bodies, who receives gross compensation therefrom at an 
annual rate of $15,000 or more.
    (iv) The holder of an elective or appointive public office in the 
executive, legislative, or judicial branch of the government of a State, 
possession of the United States, or political subdivision or other area 
of any of the foregoing, or of the District of Columbia, for which the 
gross compensation is at an annual rate of $15,000 or more, who is 
described in subparagraph (2) of this paragraph.

[[Page 204]]

    (v) The holder of a position as personal or executive assistant or 
secretary to any individual described in subdivision (i), (ii), (iii), 
or (iv) of this subparagraph.
    (2) Public office--(i) Definition. In defining the term ``public 
office'' for purposes of section 4946(c)(5) and subparagraph (1)(iv) of 
this paragraph, such term must be distinguished from mere public 
employment. Although holding a public office is one form of public 
employment, not every position in the employ of a State or other 
governmental subdivision (as described in section 4946 (c)(5)) 
constitutes a ``public office''. Although a determination whether a 
public employee holds a public office depends on the facts and 
circumstances of the case, the essential element is whether a 
significant part of the activities of a public employee is the 
independent performance of policymaking functions. In applying this 
subparagraph, several factors may be considered as indications that a 
position in the executive, legislative, or judicial branch of the 
government of a State, possession of the United States, or political 
subdivision or other area of any of the foregoing, or of the District of 
Columbia, constitutes a ``public office''. Among such factors to be 
considered in addition to that set forth above, are that the office is 
created by the Congress, a State constitution, or the State legislature, 
or by a municipality or other governmental body pursuant to authority 
conferred by the Congress, State constitution, or State legislature, and 
the powers conferred on the office and the duties to be discharged by 
such office are defined either directly or indirectly by the Congress, 
State constitution, or State legislature, or through legislative 
authority.
    (ii) Illustrations. The following are illustrations of positions of 
public employment which do not involve policymaking functions within the 
meaning of subdivision (i) of this subparagraph and which are thus not a 
``public office'' for purposes of section 4946(c)(5) and subparagraph 
(1)(iv) of this paragraph:
    (a) The chancellor, president, provost, dean, and other officers of 
a State university who are appointed, elected, or otherwise hired by a 
State Board of Regents or equivalent public body and who are subject to 
the direction and supervision of such body;
    (b) Professors, instructors, and other members of the faculty of a 
State educational institution who are appointed, elected, or otherwise 
hired by the officers of the institution or by the State Board of 
Regents or equivalent public body;
    (c) The superintendent of public schools and other public school 
officials who are appointed, elected, or otherwise hired by a Board of 
Education or equivalent public body and who are subject to the direction 
and supervision of such body;
    (d) Public school teachers who are appointed, elected, or otherwise 
hired by the superintendent of public schools or by a Board of Education 
or equivalent public body;
    (e) Physicians, nurses, and other professional persons associated 
with public hospitals and State boards of health who are appointed, 
elected, or otherwise hired by the governing board or officers of such 
hospitals or agencies; and
    (f) Members of police and fire departments, except for those 
department heads who, under the facts and circumstances of the case, 
independently perform policymaking functions as a significant part of 
their activities.
    (3) Certain government officials on leave of absence. For purposes 
of this paragraph, an individual who is otherwise described in section 
4946(c) and this paragraph who was on leave of absence without pay on 
December 31, 1969, from his position or office pursuant to a commitment 
entered into on or before such date to engage in certain activities for 
which he is paid by one or more private foundations, is not to be 
treated as holding such position or office for any continuous period 
after December 31, 1969, and prior to January 1, 1971, during which such 
individual remains on leave of absence to engage in the same activities 
for which he is paid by such foundations. For purposes of this 
subparagraph, a commitment is considered entered into on or before 
December 31, 1969, if on or before such date, the amount and nature of 
the payments to be made and the name of the

[[Page 205]]

individual receiving such payments were entered on the records of the 
payor, or were otherwise adequately evidenced, or the notice of the 
payment to be received was communicated to the payee orally or in 
writing.
    (h) Members of the family. For purposes of this section, the members 
of the family of an individual include only:
    (1) His spouse,
    (2) His ancestors,
    (3) His lineal descendants, and
    (4) Spouses of his lineal descendants.

For example, a brother or sister of an individual is not a member of his 
family for purposes of this section. However, for example, the wife of a 
grandchild of an individual is a member of his family for such purposes. 
For purposes of this paragraph, a legally adopted child of an individual 
shall be treated as a child of such individual by blood.

[T.D. 7241, 37 FR 28744, Dec. 29, 1972]



            Subpart H_Application to Certain Nonexempt Trusts



Sec. 53.4947-1  Application of tax.

    (a) In general. Section 4947 subjects trusts which are not exempt 
from taxation under section 501(a), all or part of the unexpired 
interests in which are devoted to one or more of the purposes described 
in section 170(c)(2)(B), and which have amounts in trust for which a 
deduction was allowed under section 170, 545(b)(2), 556(b)(2), 642(c), 
2055, 2106(a)(2), or 2522 to the same requirements and restrictions as 
are imposed on private foundations. The basic purpose of section 4947 is 
to prevent these trusts from being used to avoid the requirements and 
restrictions applicable to private foundations. For purposes of this 
section, a trust shall be presumed (in the absence of proof to the 
contrary) to have amounts under section 170, 545(b)(2), 556(b)(2), 
642(c), 2055, 2106(a)(2), or 2522 if a deduction would have been 
allowable under one of these sections. Also for purposes of this section 
and Sec. 53.4947-2, the term ``purposes described in section 
170(c)(2)(B)'' shall be treated as including purposes described in 
section 170(c)(1).
    (b) Charitable trusts--(1) General rule. (i) For purposes of this 
section and Sec. 53.4947-2, a charitable trust, within the meaning of 
section 4947(a)(1), is a trust which is not exempt from taxation under 
section 501(a), all of the unexpired interests in which are devoted to 
one or more of the purposes described in section 170(c)(2)(B), and for 
which a deduction was allowed under section 170, 545(b)(2), 556(b)(2), 
642(c), 2055, 2106(a)(2), or 2522 (or the corresponding provisions of 
prior law). A trust is one for which a deduction was allowed under 
section 642(c), within the meaning of section 4947(a)(1), once a 
deduction is allowed under section 642(c) to the trust for any amount 
paid or permanently set aside. (See sections 642(c) and Sec. 1.642-4 
for the limitation on such deduction in certain cases.) A charitable 
trust (as defined in this paragraph) shall be treated as an organization 
described in section 501(c)(3) and, if it is determined under section 
509 that the trust is a private foundation, then Part II of Subchapter F 
of chapter 1 of the Code (other than section 508 (a), (b) and (c) and 
Chapter 42 shall apply to the trust. However, the charitable trust is 
not treated as an organization described in section 501(c)(3) for 
purposes of exemption from taxation under section 501(a). Thus, the 
trust is subject to the excise tax on its investment income under 
section 4940(b) rather than the tax imposed by section 4940(a). For 
purposes of satisfying the organizational test described in Sec. 1.501 
(c)(3)-1(b) when a charitable trust seeks an exemption from taxation 
under section 501(a), a charitable trust (as defined in this paragraph) 
shall be considered organized on the day it first becomes subject to 
section 4947(a)(1). However, for purposes of the special and 
transistional rules in section 4940(c)(4)(B), 4942(f)(4), 
4943(c)(4)(A)(i) and (B) and section 101(1)(2)(A), (B), (C), and (D), 
and (1)(3) of the Tax Reform Act of 1969, a charitable trust (as defined 
in this paragraph) shall be considered organized on the first day it has 
amounts in trust for which a deduction was allowed (within the meaning 
of paragraph (a) of this section) under section 170, 545(b)(2), 
556(b)(2), 642(c), 2055, 2106(a)(2), or 2522. Thus, under this

[[Page 206]]

rule, a trust may be treated as a private foundation in existence on a 
date governing one of the applicable special and transistional rules 
even though the trust did not otherwise become subject to the provisions 
of Chapter 42 until a later date.
    (ii) The provisions of paragraph (b)(1) of this section may be 
illustrated by the following examples:

    Example 1. On January 30, 1970, X creates an inter vivos trust under 
which M receives 50 percent and N receives 50 percent of the trust's 
income for 10 years, and upon the termination of which, at the end of 
the 10-year period, the corpus is to be distributed to O. M, N and O are 
all organizations described in section 501(c)(3) and X is allowed a 
deduction under section 170 for the value of all interests placed in 
trust. The trustees of the trust do not give notice to the Internal 
Revenue Service under the provisions of section 508(a), and the trust 
will therefore not be exempt from taxation under section 501(a). The 
trust is a charitable trust within the meaning of section 4947(a)(1) 
from the date of its creation.
    Example 2. On March 1, 1971, Y creates a charitable remainder 
annuity trust described in section 664(d)(1) under which Z, Y's son, 
receives $10,000 per year for life, remainder to be held in trust for P, 
an organization described in section 501(c)(3). Y is allowed a deduction 
under section 170 for the present value of the remainder interest to P. 
During Z's lifetime, the trust is a split-interest trust described in 
section 4947(a)(2) and paragraph (c) of this section. Upon the death of 
Z, all unexpected interests (consisting of P's remainder interest) will 
be devoted to section 170(c)(2)(B) purposes. Except as provided in Sec. 
53.4947-1(b)(2)(iv) (relating to a reasonable period of settlement) the 
trust will be treated as a charitable trust within the meaning of 
section 4947(a)(1) from the date of the death of Z unless the trustees 
of the trust apply for recognition of section 501(c)(3) status under the 
provisions of section 508(a).

    (2) Scope of application of section 4947(a)(1)--(i) In general. 
Subject to paragraph (b)(2) (ii) through (vii) of this section, section 
4947(a)(1) applies to nonexempt trusts in which all unexpired interests 
are charitable. For purposes of this section, the term charitable when 
used to describe an interest or beneficiary refers to the purposes 
described in section 170(c)(2)(B). An estate from which the executor or 
administrator is required to distribute all of the net assets in trust 
to such beneficiaries will not be considered a charitable trust under 
section 4947(a)(1) during the period of estate administration or 
settlement, except as provided in paragraph (b)(2)(ii) of this section. 
A charitable trust created by will shall be considered a charitable 
trust under section 4947(a)(1) as of the date of death of the decedent-
grantor, except as provided in paragraph (b)(2)(v) of this section 
(relating to trusts which wind up. For the circumstances under which 
segregated amounts are treated as charitable trusts, see Sec. 53.4947-
1(c)(3)(iii).
    (ii) Estates. (A) When an estate from which the executor or 
administrator is required to distribute all of the net assets in trust 
for charitable beneficiaries, or free of trust to such beneficiaries, is 
considered terminated for Federal income tax purposes under Sec. 
1.641(b)-3(a), then the estate will be treated as a charitable trust 
under section 4947(a)(1) between the date on which the estate is 
considered terminated under Sec. 1.641(b)-3(a) and the date final 
distribution of all of the net assets is made to or for the benefit of 
the charitable beneficiaries. This (ii) does not affect the 
determination of the tax liability under Subtitle A of the beneficiaries 
of the estates.
    (B) The provisions of this (ii) may be illustrated by the following 
example:

    Example. X bequeaths his entire estate, including 100 percent of the 
stock of a wholly-owned corporation, to M, an organization described in 
section 501(c)(3), under a will which gives his executor authority to 
hold the stock and manage the corporation for a period of up to 10 years 
for the benefit of M prior to its ultimate disposition. A deduction for 
the charitable bequest was allowed to X's estate under section 2055. The 
executor is vested with a full range of powers, including the power of 
sale. Upon the death of X, his executor distributes X's assets to M 
except for the stock of the corporation, which he holds for 5 years 
prior to its disposition. The continued holding of the stock of the 
corporation by the executor after the expiration of a reasonable time 
for performance of all the ordinary duties of administration causes the 
estate to be considered terminated for Federal income tax purposes 
pursuant to Sec. 1.641(b)-3(a) and thereby subjects it to the 
provisions of section 4947(a)(1) from the date of such termination to 
the date of final disposition of the stock of the corporation.


[[Page 207]]


    (iii) Certain split-interest trusts which wind up. A split-interest 
trust (as defined in paragraph (c) of this section) in which all of the 
unexpired interests are charitable remainder interests and in which the 
charitable beneficiaries have become entitled to distributions of corpus 
in trust or free of trust shall continue to be treated as as split-
interest trust under section 4947(a)(2) until the date on which final 
distribution of all the net assets is made. However, if after the 
expiration of any intervening interests the trust is considered 
terminated for Federal income tax purposes under Sec. 1.641(b)-3(b), 
then the trust will be treated as a charitable trust under section 
4947(a)(1), rather than a split interest trust under section 4947(a)(2), 
between the date on which the trust is considered terminated under Sec. 
1.641(b)-3(b) and the date on which such final distribution of all of 
the net assets is made to or for the benefit of the charitable remainder 
beneficiaries. This (iii) does not affect the determination of the tax 
liability under subtitle A of the beneficiaries of the trusts.
    (iv) Split-interest trusts which become charitable trusts. (A) A 
split-interest trust (as defined in paragraph (c) of this section) in 
which all of the unexpired interests are charitable remainder interests 
and in which some or all of the charitable beneficiaries are not 
entitled to distributions of corpus within the meaning of paragraph 
(b)(2)(iii) of this section shall continue to be treated as a split-
interest trust under section 4947(a)(2) rather than a charitable trust 
under section 4947(a)(1) for a reasonable period of settlement after the 
expiration of the noncharitable interest. Thus, a split-interest trust 
which under its terms is to continue to hold assets for charitable 
beneficiaries after the expiration of the noncharitable interest rather 
than distributing them as in paragraph (b)(2)(iii) of this section is 
given a reasonable period of settlement before being treated as a 
charitable trust. For purposes of this paragraph, the term reasonable 
period of settlement means that period reasonably required (or if 
shorter, actually required) by the trustee to perform the ordinary 
duties of administration necessary for the settlement of the trust. 
These duties include, for example, the collection of assets, the payment 
of debts, taxes, and distributions, and the determination of the rights 
of the subsequent beneficiaries.
    (B) This (iv) may be illustrated by the following example:

    Example. On January 15, 1971, A creates a charitable remainder 
annuity trust described in section 661(d)(1) under which the trustees 
are required to distribute $10,000 a year to B, A's wife, for life, 
remainder to be held in trust for the use of M, an organization 
described in section 501(c)(3). A is allowed a deduction under section 
170 for the amount of the charitable interest, and the trust is, 
therefore, treated as a split-interest trust under section 4947(a)(2) 
from the date of its creation. B dies on February 10, 1975. On April 15, 
1975, the trustees complete performance of the ordinary duties of 
administration necessary for the settlement of the trust brought about 
by the death of B. These duties include, for example, an accounting for 
and payment to the estate of B of amounts accrued by B while alive 
during 1975. However, the trustees do not distribute the corpus to M by 
April 15, 1975. The trust shall continue to be treated as a split-
interest trust under section 4947(a)(2) until April 15, 1975. After 
April 15, 1975, the trust shall be treated as a charitable trust under 
section 4947(a)(1).

    (v) Certain revocable and testamentary trusts which wind up. A 
revocable trust that becomes irrevocable upon the death of the decedent-
grantor, or a trust created by will, from which the trustee is required 
to distribute all of the net assets in trust for or free of trust to 
charitable beneficiaries is not considered a charitable trust under 
section 4947(a)(1) for a reasonable period of settlement (within the 
meaning of paragraph (b)(2)(iv) of this section) after becoming 
irrevocable. After that period the trust is considered a charitable 
trust under section 4947(a)(1).
    (vi) Revocable trusts which become charitable trusts. A revocable 
trust that becomes irrevocable upon the death of the decedent-grantor in 
which all of the unexpired interests are charitable and under the terms 
of the governing instrument of which the trustee is required to hold 
some or all of the net assets in trust after becoming irrevocable solely 
for charitable beneficiaries is not considered a trust under section

[[Page 208]]

4947(a)(1) for a reasonable period of settlement (within the meaning of 
paragraph (b)(2)(iv) of this section) after becoming irrevocable except 
that section 4941 may apply if the requirements of Sec. 53.4941(d)-1 
(b)(3) are not met. After that period, the trust is considered a 
charitable trust under section 4947(a)(1).
    (vii) Trust devoted to 170(c) purposes. (A) A trust all of the 
unexpired interests in which are devoted to section 170 (c) (3) or (5) 
purposes together with section 170(c)(2)(B) purposes shall be considered 
a charitable trust except that payments under the terms of the governing 
instrument to an organization described in section 170(c) (3) or (5) 
shall not be considered a violation of section 4945(d)(5) or any other 
provisions of Chapter 42 and shall be considered qualifying 
distributions under section 4942.
    (B) Example. The application of paragraph (b)(2)(vii) of this 
section may be illustrated by the following example:

    Example. On January 30, 1970, H creates an inter vivos trust under 
the terms of the governing instruments of which M, an organization 
described in section 170(c)(3), and N, an organization described in 
section 501(c)(3), are each to receive 50 percent of the income for a 
period of 10 years. At the end of the 10 year period, the corpus is to 
be distributed to O, an organization also described in section 
501(c)(3). H is allowed a deduction under section 170 for the value of 
all interests placed in trust. The payments to M do not constitute a 
violation of section 4945(d)(5) or any other provision of Chapter 42 and 
constitute qualifying distributions under section 4942. However, except 
as provided in the previous sentence, the trust shall be considered a 
charitable trust.

    (3) Charitable trusts described in section 509(a)(3). For purposes 
of section 509(a)(3)(A), a charitable trust shall be treated as if 
organized on the day on which it first becomes subject to section 
4947(a)(1). However, for purposes of applying Sec. Sec. 1.509(a)-4(d) 
(2)(iv)(a), and 1.509(a)-4(i)(1) (ii) and (iii)(c) the previous 
relationship between the charitable trust and the section 509(a) (1) or 
(2) organizations it benefits or supports may be considered. If the 
charitable trust otherwise meets the requirements of section 509(a)(3), 
it may obtain recognition of its status as a section 509(a)(3) 
organization by requesting a ruling from the Internal Revenue Service. 
For the special rules pertaining to the application of the 
organizational test to organizations terminating their private 
foundation status under the 12-month or 60-month termination period 
provided under section 507(b)(1)(B) by becoming ``public'' under section 
509(a)(3), see the regulations under section 507(b)(1).
    (c) Split-interest trusts--(1) General rule--(i) Definition. For 
purposes of this section and Sec. 53.4947-2, a split-interest trust, 
within the meaning of section 4947(a)(2), is a trust which is not exempt 
from taxation under section 501(a), not all of the unexpired interests 
in which are devoted to one or more of the purposes described in section 
170(c)(2)(B), and which has amounts in trust for which a deduction was 
allowed (within the meaning of paragraph (a) of this section) under 
section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522. A 
trust is one which has amounts in trust for which a deduction was 
allowed under section 642(c) within the meaning of section 4947(a)(2) 
once a deduction is allowed under section 642(c) to the trust for any 
amount permanently set aside. This (i) also includes any trust which is 
not treated as a charitable trust by operation of paragraph (b)(2) (iii) 
or (iv) of this section (relating to split-interest trusts in the 
process of winding up or during a reasonable period of settlement). 
Section 4947(a)(1) shall apply to a trust described in this (i) (without 
regard to section 4947(a)(2)(A), (B), or (C)) from the first date upon 
which the provisions of paragraph (b)(2) (iii) or (iv) of this section 
are satisfied. For the circumstances under which a trust all of the 
unexpired interests in which are devoted to section 170(c) (3) or (5) 
purposes together with section 170(c)(2)(B) purposes is considered a 
charitable trust, see Sec. 53.4947-1(b)(2)(vii).
    (ii) Applicability of statutory rules. A split-interest trust is 
subject to the provisions of section 507 (except as provided in 
paragraph (e) of this section), 508(e) (to the extent applicable to a 
split-interest trust), 4941, 4943 (except as provided in section 
4947(b)(3)), 4944 (except as provided in section 4947(b)(3)), and 4945 
in the same manner

[[Page 209]]

as if such trust were a private foundation.
    (iii) Special rules. A newly created trust shall, for purposes of 
section 4947(a)(2), be treated as having amounts in trust for which a 
deduction was allowed under section 170, 545(b)(2), 556(b)(2), 642(c), 
2055, 2106(a)(2), or 2522 from the date of its creation, even if a 
deduction was allowed for such amounts only at a later date. For 
purposes of this (iii), the date of creation of a charitable remainder 
trust shall be determined by applying the rules in Sec. 1.664-1(a)(4).
    (2) Exception for amounts payable to income beneficiaries. (i) Under 
section 4947(a)(2)(A), paragraph (c)(1)(ii) of this section does not 
apply to any amounts payable under the terms of a split-interest trust 
to income beneficiaries unless a deduction was allowed under section 
170(f)(2)(B), 2055(e)(2) (B), or 2522(c)(2)(B) with respect to the 
income interest of any such beneficiary. See Sec. 1.170A-6(c), Sec. 
20.2055(e)(2), and Sec. 25.2522(c)-3(c)(2) for rules regarding the 
allowance of these deductions. However, section 4947(a)(2)(A) does not 
apply when the value of all interests in property transferred in trust 
are deductible under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 
2106(a)(2), or 2522.
    (ii) The application of this subparagraph may be illustrated by the 
following examples:

    Example 1. H creates a charitable remainder unitrust (described in 
section 664(d)(2)) which is required annually to pay W, H's wife, 5 
percent of the net fair market value of the trust assets, valued 
annually, for her life; and to pay the remainder to Y, a section 
501(c)(3) organization. A deduction under section 170(f)(2)(A) was 
allowed with respect to the remainder interest of Y. Under section 
4947(a)(2)(A), each annual amount which becomes payable to W during her 
life is not subject to paragraph (c)(1)(ii) of this section on or after 
the date upon which it becomes so payable and the payment of each amount 
to W is not an act of self-dealing under section 4941(d)(1) and does not 
violate any other provision of chapter 42. However, except as provided 
in the preceding sentence, the trust is subject to paragraph (c)(1)(ii) 
of this section in the same manner as any other split-interest trust.
    Example 2. H bequeaths the residue of his estate in trust for the 
benefit of S, his son, and Y, an organization described in section 
501(c)(3). A guaranteed annuity interest of $10,000 is to be paid to S 
for 20 years. A guaranteed annuity interest of $5,000 which meets the 
requirements contained in Sec. 20.2055-2(e)(2)(v)(a) is also to be paid 
to Y for 20 years. Upon termination of the 20-year term, the corpus is 
to be distributed to Z, another organization described in section 
501(c)(3). The trust is a charitable remainder annuity trust as 
described in section 664(d)(1) and the regulations thereunder, and a 
deduction under section 2055(e)(2)(A) was allowed with respect to the 
remainder interest of Z. A deduction was also allowed under section 
2055(e)(2)(B) with respect to the guaranteed annuity interest of Y. The 
assets in the trust are not segregated under section 4947(a)(2)(B) and 
paragraph (c)(3) of this section. Under section 4947(a)(2)(A), each 
payment of $10,000 to S is not subject to section 4947(a)(2) and 
paragraph (c)(1)(ii) of this section. The payment of each amount to S is 
not an act of self-dealing under section 4941(d)(1) and does not violate 
any other provision of chapter 42. However, except as provided in the 
preceding sentence, the trust is subject to section 4947(a)(2) and 
paragraph (c)(1)(ii) of this section in the same manner as any other 
split-interest trust.
    Example 3. H creates a trust under which the trustees are required 
to pay over an annuity interest of $20,000 to W. H's wife, for her life. 
A guaranteed annuity interest of $10,000 which meets the requirements 
contained in Sec. 25.2522(c)-3(c)(2)(v) is also to be paid X, an 
organization described in section 501(c)(3), for the life of W. Upon the 
death of W, the corpus of the trust, which consists of office buildings 
M and N, is to be distributed to S. H's son. H received a deduction 
under section 2522(c)(2)(B) for the value of X's income interest in the 
trust. The assets in the trust are not segregated under section 
4947(a)(2)(B) and paragraph (c)(3) of this section. Under section 
4947(a)(2)(A), each payment of $20,000 to W is not subject to section 
4947(a)(2) and paragraph (c)(1)(ii) of this section. The payment of each 
amount to W is not an act of self-dealing under section 4941(d)(1) and 
does not violate any other provision of chapter 42. However, except as 
provided in the preceding sentence, the trust is subject to paragraph 
(c)(1)(ii) of this section in the same manner as any other split-
interest trust. See example (1) of paragraph (c)(3)(v) of this section 
for the application of section 4947(a)(2)(B) to a similar trust where 
the trustees segregate the assets of the trust.

    (3) Exception for certain segregated amount--(i) In general. Under 
section 4947(a)(2)(B) paragraph (c)(1)(ii) of this section does not 
apply to assets held in trust (together with the income and capital 
gains derived from the assets), which are segregated from other assets 
held in trust for which a deduction was

[[Page 210]]

allowed for an income or remainder interest under section 170, 
545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522.
    (ii) Segregation of amounts. Amounts will generally be considered 
segregated (within the meaning of section 4947(a)(2)(B) if:
    (A) Assets with respect to which no deduction was allowed (for an 
income or remainder interest) under section 170, 545(b)(2), 556(b)(2), 
642(c), 2055, 2106(a)(2), or 2522, are separately accounted for under 
section 4947(a)(3) and paragraph (c)(4) of this section from assets for 
which such a deduction was allowed for any income or remainder interest 
and,
    (B) By reason of the separate accounting the trust can be treated as 
two separate trusts, one of which is devoted exclusively to 
noncharitable income and remainder interests and the other of which is a 
charitable trust described in section 4947(a)(1) or a split-interest 
trust described in section 4947(a)(2).

Under these circumstances, only the ``trust'' which is devoted 
exclusively to noncharitable income and remainder interests will be 
considered a segregated amount which under section 4947(a)(2)(B), is not 
subject to section 4947(a)(2) and paragraph (c)(1)(ii) of this section.
    (iii) Exclusively charitable amounts. If, under section 
4947(a)(2)(B),
    (A) An amount held in trust which is devoted exclusively to 
noncharitable income and remainder interests is segregated from
    (B) An amount held in trust which is devoted exclusively to 
charitable income and remainder interests,

Then for purposes of this section the amount described in paragraph 
(c)(3)(iii)(B) of this section will be treated as a charitable trust 
which is subject to the provisions of section 4947(a)(1).
    (iv) Charitable and noncharitable amounts. If, under section 4947(a) 
(2)(B),
    (A) An amount held in trust which is devoted exclusively to 
noncharitable income and remainder interests is segregated from
    (B) An amount held in trust which is devoted to both charitable 
income or remainder interests and noncharitable income or remainder 
interests,

Then for purposes of this section the amount described in paragraph 
(c)(3)(iv)(B) of this section will be treated as a split-interest trust 
which is subject to the provisions of section 4947(a)(2).
    (v) Examples. The application of paragraph (c)(3) of this section 
may be illustrated by the following examples:

    Example 1. H creates a trust under which the trustees are required 
to pay over annually 5 percent of the net fair market value of M 
building, valued annually, to W, H's wife, for life, remainder to S, H's 
son. The other asset in the trust is N building, with respect to which 
the trustees are required to pay over annually 5 percent of the net fair 
market value of the building, valued annually, to X, a section 501(c)(3) 
organization, for a period of 15 years, remainder to S. Each asset is 
separately accounted for under section 4947(a)(3) and paragraph (c)(4) 
of this section. He received a deduction under section 2522 for the 
value of X's income interest in N building. Under these circumstances, M 
building is considered segregated (within the meaning of section 
4947(a)(2)(B)) from N building and is not subject to section 4947 
(a)(2). The remainder interest of S in N building is not considered 
segregated from the income interest of X in N building, since both are 
interests in the same asset. N building is considered held in a split-
interest trust which is subject to section 4947 (a)(2) and paragraph 
(c)(1)(ii) of this section.
    Example 2. H transfers $50,000 in trust to pay $2,500 per year to Z, 
a section 501(c)(3) organization, for a term of 20 years, remainder to 
S. H's son. H is allowed a deduction under section 2522 for the present 
value of Z's income interest. The income interest of Z in the trust 
asset cannot be segregated (within the meaning of section 4947(a)(2)(B)) 
from the remainder interest of S since both are interests in the same 
asset. Therefore, the entire trust is subject to section 4947(a)(2) and 
paragraph (c)(1)(ii) of this section.

    (4) Accounting for segregated amounts--(i) General rule. Under 
section 4947(a)(2)(B), a trust with respect to which amounts are 
segregated within the meaning of paragraph (c)(3) of this section must 
separately account for the various income, deduction, and other items 
properly attributable to each segregated amount in the books of account 
and separately account to each of the beneficiaries of the trust.
    (ii) Method. Separate accounting shall be made:

[[Page 211]]

    (A) According to the method regularly employed by the trust, if the 
method is reasonable, and
    (B) In all other cases in a manner which, in the opinion of the 
Commissioner, is reasonable.

A method of separate accounting will be considered ``regularly 
employed'' by a trust when the method has been consistently followed in 
prior taxable years or when a trust which has never before maintained 
segregated amounts initiates a reasonable method of separate accounting 
for its segregated amounts and consistently follows such method 
thereafter. The trust shall keep permanent records and other data 
relating to the segregated amounts as are necessary to enable the 
district director to determine the correctness of the application of the 
rules prescribed in paragraph (c) (3) and (4) of this section.
    (5) Amounts transferred in trust before May 27, 1969--(i) General 
rule. Under section 4947(a)(2)(C), paragraph (c)(1)(ii) of this section 
does not apply to any amounts transferred in trust before May 27, 1969. 
For purposes of this (5), an amount shall be considered to be 
transferred in trust only when the transfer is one which meets the 
requirements for the allowance of a deduction under section 170, 
545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 (or the 
corresponding provisions of prior law). Income and capital gains which 
are derived at any time from amounts transferred in trust before May 27, 
1969, shall also be excluded from the application of paragraph 
(c)(1)(ii) of this section. If an asset which was transferred in trust 
before May 27, 1969, is sold or exchanged after May 26, 1969, any asset 
received by the trust upon the sale or exchange shall be treated as an 
asset which was transferred in trust before May 27, 1969.
    (ii) Requirement for separate accounting for amounts transferred in 
trust before May 27, 1969. If:
    (A) Amounts are transferred in trust after May 26, 1969, and the 
trust to which the amounts are transferred also contains
    (B) Amounts transferred in trust before May 27, 1969,

the general rule of paragraph (c)(5)(i) of this section applicable to 
the amounts described in paragraph (c)(5)(ii)(B) of this section will 
apply only if the amounts described in paragraph (c)(5)(ii)(A) of this 
section (together with all income and capital gains derived therefrom) 
are separately accounted for (within the meaning of paragraph (c)(4) of 
this section) from the amounts described in paragraph (c)(5)(ii)(B) of 
this section, together with all income and capital gains derived 
therefrom. For the application of section 508(e) to a trust with respect 
to which amounts were transferred both before and after May 27, 1969, 
see section 508(e) and the regulations thereunder.
    (iii) Exception for certain testamentary trusts. (A) Amounts 
transferred in trust before May 27, 1969 include amounts transferred in 
trust after May 26, 1969 when the transfer is made under the terms of a 
testamentary trust created by the will of a decedent who died before May 
27, 1969, (regardless of whether the executors or the testamentary 
trustees are required to execute testamentary trusts by court order 
under applicable local law). Amounts transferred in trust before May 27, 
1969, also include amounts transferred to a testamentary trust created 
by the will of a decedent who died after May 26, 1969 if the will was 
executed before May 27, 1969 and no dispositive provision of the will 
was amended (within the meaning of Sec. 20.2055-2(e)(4) and (5)) by the 
decedent by codicil or otherwise, after May 26, 1969, and the decedent 
was on May 27, 1969, and at all times thereafter under a mental 
disability (as defined in Sec. 1.642(c)-2(b)(3)(ii)) to amend the will 
by codicil or otherwise.
    (B) The provisions of this (iii) may be illustrated by the following 
example:

    Example. X executed a will in 1960 which provided for the creation 
of a testamentary trust which meets the description of a split-interest 
trust under section 4947(a)(2). X died on April 15, 1969. Under the 
provisions of his will, the probate court permitted certain property in 
X's estate to be transferred to the testamentary trust at fixed 
intervals over a period of two years during the administration of the 
estate. Section 4947(a)(2) does not apply to any amount described in 
this example, including the amounts transferred after May 26, 1969, 
because, for purposes of section 4947(a)(2)(C), each such transfer will 
be treated as an amount transferred in trust

[[Page 212]]

before May 27, 1969, within the meaning of section 4947(a)(2)(C).

    (6) Scope of application of section 4947(a)(2)--(i) In general. 
Subject to paragraph (c)(6) (ii), (iii), and (iv) of this section, 
section 4947(a)(2) applies to trusts in which some but not all unexpired 
interests are charitable. An estate from which the executor or 
administrator is required to distribute all of the net assets in trust 
or free of trust to both charitable and noncharitable beneficiaries will 
not be considered to be a split-interest trust under section 4947(a)(2) 
during the period of estate administration or settlement, except as 
provided in paragraph (c)(6)(ii) of this section. A split-interest trust 
created by will shall be considered a split-interest trust under section 
4947(a)(2) as of the date of death of the decedent-grantor, except as 
provided in paragraph (c)(6)(iv) of this section.
    (ii) Estates. (A) When an estate from which the executor or 
administrator is required to distribute all of the net assets in trust 
or free of trust to both charitable and noncharitable beneficiaries is 
considered terminated for Federal income tax purposes under Sec. 
1.641(b)-3(a), then the estate will be treated as a split-interest trust 
under section 4947(a)(2) (or a charitable trust under section 
4957(a)(1), if applicable) between the date on which the estate is 
considered terminated under Sec. 1.641(b)-3(a) and the date on which 
final distribution of the net assets to the last remaining charitable 
beneficiary is made. This (ii) does not affect the determination of the 
tax liability under subtitle A of either charitable or noncharitable 
beneficiaries of the estates.
    (B) The provisions of this (ii) may be illustrated by the following 
example:

    Example. X dies on January 15, 1973 and bequeaths $10,000 to M, an 
organization described in section 501(c)(3), and the residue of his 
estate to W, his wife. A deduction for the charitable bequest was 
allowed to X's estate under section 2055. Substantially all of X's 
estate consists of 100 percent of the stock of a wholly owned 
corporation, certain liquid assets such as marketable stocks and 
securities and bank accounts, and X's home, automobile, and other 
personal property. X's will gives his executor a full range of powers, 
including the power to sell the stock of the wholly owned corporation. 
After the death of X, his executor continues to manage the wholly owned 
corporation while attempting to sell the stock of the corporation. 
During this period, the executor makes no distributions to M. On May 24, 
1978, the Internal Revenue Service determines under Sec. 1.641(b)-3(a) 
that the administration of the estate has been unduly prolonged and the 
estate is considered terminated as of that date for Federal income tax 
purposes. X's estate will be treated as a split-interest trust described 
in section 4947(a)(2) between May 24, 1978 and the date on which the 
$10,000 bequest to M is satisfied. X's estate will therefore be subject 
to the applicable private foundation provisions during that period and, 
for example, a sale of the house by the estate to any disqualified 
person (as defined in section 4946) will be an act of self-dealing under 
section 4941.

    (iii) Revocable trusts which become split-interest trusts. A 
revocable trust that becomes irrevocable upon the death of the decedent-
grantor under the terms of the governing instrument of which the trustee 
is required to hold some or all of its net assets in trust after 
becoming irrevocable for both charitable and noncharitable beneficiaries 
is not considered a split-interest trust under section 4947(a)(2) for a 
reasonable period of settlement after becoming irrevocable except that 
section 4941 may apply if the requirements of Sec. 53.4941(d)-1(b)(3) 
are not met.

After that period, the trust is considered a split-interest trust under 
section 4947(a)(2). For purposes of this (iii), the term reasonable 
period of settlement means that period reasonably required (or if 
shorter, actually required) by the trustee to perform the ordinary 
duties of administration necessary for the settlement of the trust. 
These duties include, for example, the collection of assets, the payment 
of debts, taxes, and distributions, and the determination of rights of 
the subsequent beneficiaries.
    (iv) Certain revocable and testamentary trusts which wind up. A 
revocable trust that becomes irrevocable upon the death of the decedent-
grantor, or a trust created by will, from which the trustee is required 
to distribute all of the net assets in trust or free of trust to both 
charitable and noncharitable beneficiaries is not considered a split-
interest trust under section 4947(a)(2) for a reasonable period of 
settlement (within the meaning of paragraph (c)(6)(iii) of this section) 
after becoming irrevocable. After that period, the

[[Page 213]]

trust is considered a split-interest trust under section 4947(a)(2) (or 
a charitable trust under section 4947(a)(1), if applicable).
    (d) Cross references; Governing instrument requirements and 
charitable deduction limitations. For the application of section 
642(c)(6) (relating to section 170 limitations on charitable deductions 
of non-exempt private foundation trusts) to a trust described in section 
4947(a)(1), see Sec. 1.642(c)-4. For the denial of a deduction under 
section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 for 
a gift, a bequest, or an amount paid to (and the denial of a deduction 
under section 642(c) for an amount set aside in) a trust described in 
section 4947(a)(1) or (2) that fails to meet the applicable governing 
instrument requirements of section 508(e) by the end of the taxable year 
of the trust, see section 508(d)(2) and Sec. 1.508-2(b). Since a 
charitable remainder trust (as defined in section 664) is not exempt 
under section 501(a), it is subject to section 4947(a)(2), and thus to 
the governing instrument requirements of section 508(e) to the extent 
they are applicable.
    (e) Application of section 507(a)--(1) General rule. The provisions 
of section 507(a) shall not apply to a trust described in section 
4947(a) (1) or (2) by reason of any payment to a beneficiary that is 
directed by the terms of the governing instrument of the trust and is 
not discretionary with the trustee or, in the case of a discretionary 
payment, by reason of, or following, the expiration of the last 
remaining charitable interest in the trust.
    (2) Examples. The provisions of this (e) may be illustrated by the 
following examples:

    Example 1. H creates a section 4947(a)(1) trust under which the 
income is to be paid for 15 years to R, a section 501(c)(3) 
organization. Upon the expiration of 15 years, the trust is to terminate 
and distribute all of its assets to S, another section 501(c)(3) 
organization. Distribution of the corpus of the trust to S will not be 
considered a termination of the trust's private foundation status within 
the meaning of section 507(a).
    Example 2. H creates a trust under which X, a section 501(c)(3) 
organization, receives $20,000 per year for a period of 20 years, 
remainder to S, H's son. H is allowed a deduction under section 2522 for 
the present value of X's interest.
    When the final payment to X has been made at the end of the 20-year 
period in accordance with the terms of the trust, the provisions of 
section 4947(a)(2) will cease to apply to the trust because the trust no 
longer retains any amounts for which the deduction under section 2522 
was allowed. However, the final payment to X will not be considered a 
termination of the trust's private foundation status within the meaning 
of section 507(a).
    Example 3. J creates a charitable remainder annuity trust described 
in section 664(d)(1) under which S, J's son, receives $10,000 per year 
for life, remainder to be distributed outright to P, an organization 
described in section 501(c)(3). J is allowed a deduction under section 
170 for the value of the remainder interest placed in trust for the 
benefit of P, and the provisions of section 4947(a)(2) apply to the 
trust. At the death of S, the trust will terminate and all assets will 
be distributed to P. However, such final distribution to P will not be 
considered a termination of the trust's private foundation status within 
the meaning of section 507(a).

[T.D. 7431, 41 FR 35515, Aug. 23, 1976]



Sec. 53.4947-2  Special rules.

    (a) Limit to segregated amounts. If any amounts held in trust are 
segregated within the meaning of Sec. 53.4947-1(c)(3), the value of the 
net assets for purposes of section 507(c)(2) and (g) shall be limited to 
the segregated amounts with respect to which a deduction under section 
170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 was 
allowed. See the regulations under section 507(c)(2) and (g).
    (b) Applicability of section 4943 and 4944 to split-interests 
trusts--(1) General rule. Under section 4947(b)(3), section 4943 and 
4944 do not apply to a split-interest trust described in section 
4947(a)(2) if:
    (i) All the income interest (and none of the remainder interest) of 
the trust is devoted solely to one or more of the purposes described in 
section 170(c)(2)(B) and all amounts in the trust for which a deduction 
was allowed under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 
2106(a)(2), or 2522 have an aggregate value (at the time for which the 
deduction was allowed) of not more than 60 percent of the aggregate fair 
market value of all amounts in the trust (after the payment of estate 
taxes and all other liabilities), or

[[Page 214]]

    (ii) A deduction was allowed under section 170, 545(b)(2), 
556(b)(2), 642(c), 2055, 2106(a)(2) or 2522 for amounts payable under 
the terms of the trust to every remainder beneficiary, but not to any 
income beneficiary.

This (1) shall apply to a trust described in paragraph (b)(1)(ii) of 
this section only if all amounts payable under the terms of the trust to 
every remainder beneficiary are to be devoted solely to one or more of 
the purposes described in section 170(c)(2)(B). After the expiration of 
all income interests in a trust described in paragraph (b)(1)(ii) of 
this section, the trust shall become subject to section 4947(a)(1) under 
Sec. 53.4947-1(b)(2), and section 4947(b)(3) shall no longer apply to 
the trust. A pooled income fund described in section 642(c)(5) will 
generally meet the requirements of paragraph (b)(1)(ii) of this section, 
as will a charitable remainder trust described in section 664(d)(1), if 
in either case it does not make payments to any income beneficiary 
described in section 170(c).
    (2) Definitions. (i) For purposes of section 4947(b)(3)(A), the term 
``income interest'' shall include an interest in property transferred in 
trust which is in the form of a guaranteed annuity interest or unitrust 
interest as described in Sec. 1.170A-6(c), Sec. 20.2055-2(e)(2) or 
Sec. 25.2522(c)-3(c)(2) and the term ``remainder interest'' shall 
include an interest which succeeds an ``income interest'' within the 
meaning of this (i).
    (ii) For purposes of section 4947(b)(3)(B), the term ``income 
beneficiary'' shall include a recipient of payments described in section 
642(c)(5)(F) from a pooled income fund, payments described in section 
664(d)(1)(A) from a charitable remainder annuity trust, or payments 
described in section 664(d)(2)(A) or (3) from a charitable remainder 
unitrust. The term ``remainder beneficiary'' shall include a beneficiary 
of a remainder interest described in section 642(c)(5) or 664(d)(1)(C) 
or (2)(C).
    (c) Effective date. Except as otherwise provided in Sec. Sec. 
53.4947-1 and 53.4947-2 and the regulations under sections 508 (d) and 
(e), Sec. Sec. 53.4947-1 and 53.4947-2 shall take effect on January 1, 
1970.

(Secs. 4947 and 7805, Internal Revenue Code of 1954 (68A Stat. 917: 26 
U.S.C. 7805))

[T.D. 7431, 41 FR 35515, Aug. 23, 1976]



Subpart I_Tax on Investment Income of and Denial of Exemption to Certain 
                          Foreign Organizations



Sec. 53.4948-1  Application of taxes and denial of exemption with 
respect to certain foreign organizations.

    (a) Tax on income of certain foreign organizations. (1) In lieu of 
the tax imposed by section 4940 and the regulations thereunder, there is 
hereby imposed for each taxable year beginning after December 31, 1969, 
on the gross investment income (within the meaning of section 4940(c)(2) 
and the regulations thereunder) derived from sources within the United 
States (within the meaning of section 861 and the regulations 
thereunder) by every foreign organization which is a private foundation 
(within the meaning of section 509 and the regulations thereunder) and 
exempt from taxation under section 501(a) for the taxable year a tax 
equal to 4 percent of such income, except as provided in subparagraph 
(3) of this paragraph. The tax (if any) will be reported on the form the 
foundation is required to file under section 6033 and will be paid 
annually for the taxable year, at the time prescribed for filing such 
annual return (determined without regard to any extension of time for 
filing). For purposes of this section, the term foreign organization 
means any organization which is not described in section 170(o)(2)(A).
    (2) With respect to the deduction and withholding of tax imposed by 
section 4948(a), see section 1443(b) and the regulations thereunder.
    (3) Whenever there exists a tax treaty between the United States and 
a foreign country, and a foreign private foundation subject to section 
4948(a) is a resident of such country or is otherwise entitled to the 
benefits of such treaty (whether or not such benefits are available to 
all residents), if the treaty provides that any item or items

[[Page 215]]

(or all items with respect to an organization exempt from income 
taxation) of gross investment income (within the meaning of section 
4940(c)(2)) shall be exempt from income tax, such item or items shall 
not be taken into account by such foundation in computing the tax to be 
imposed under section 4948(a) for any taxable year for which the treaty 
is effective.
    (b) Certain sections inapplicable. Section 507 (relating to 
termination of private foundation status), section 508 (relating to 
special rules with respect to section 501(c)(3) organizations), and 
Chapter 42 (other than section 4948) of the Code shall not apply to any 
foreign organization which from the date of its creation has received at 
least 85 percent of its support (as defined in section 509(d), other 
than section 509(d)(4)) from sources outside the United States. For 
purposes of this paragraph, gifts, grants, contributions, or membership 
fees directly or indirectly from a United States person (as defined in 
section 7701(a)(30)) are from sources within the United States.
    (c) Denial of exemption to foreign organizations engaged in 
prohibited transactions--(1) In general. A foreign private foundation 
described in section 4948(b) and paragraph (b) of this section shall not 
be exempt from taxation under section 501(a) if it has engaged in a 
prohibited transaction (within the meaning of subparagraph (2) of this 
paragraph) after December 31, 1969.
    (2) Prohibited transactions. (i) For purposes of this section, the 
term ``prohibited transaction'' means any act or failure to act (other 
than with respect to section 4942(e), relating to minimum investment 
return) which would subject a foreign private foundation described in 
paragraph (b) of this section, or a disqualified person (as defined in 
section 4946) with respect thereto, to liability for a penalty under 
section 6684 (relating to assessable penalties with respect to liability 
for tax under Chapter 42) or a tax under section 507 (relating to 
termination of private foundation status) if such foreign private 
foundation were a domestic private foundation.
    (ii) For purposes of subdivision (i) of this subparagraph:
    (a) Approval by an appropriate foreign government of grants by the 
foreign private foundation to individuals is sufficient to satisfy the 
requirements of section 4945(g) and the regulations thereunder.
    (b) In determining whether a grantee of the foreign organization is 
a private foundation which is not an operating foundation for purposes 
of section 4942(g)(1)(A)(ii) or is an organization which is not 
described in section 509(a) (1), (2), or (3) for purposes of section 
4945 (d)(4) and (h), a determination made by such foreign organization 
will be accepted if such determination is made in good faith after a 
reasonable effort to identify the status of its grantee.
    (iii) For purposes of subdivision (i) of this subparagraph, in order 
for an act or failure to act (without regard to section 4942(e)) to be 
treated as a prohibited transaction under section 4948(c)(2) by reason 
of the application of section 6684(1), there must have been a prior act 
or failure to act (without regard to section 4942(e)), which:
    (a) Would have resulted in liability for tax under Chapter 42 (other 
than section 4940 or 4948(a)) if the foreign private foundation had been 
a domestic private foundation, and
    (b) Had been the subject of a warning from the Commissioner that a 
second act or failure to act (without regard to section 4942(e)) would 
result in a prohibited transaction.

The second act or failure to act (with respect to which a warning 
described in subparagraph (3)(i) of this paragraph is given) need not be 
related to the prior act or failure to act with respect to which a 
warning from the Commissioner was given under (b) of this subdivision.
    (3) Taxable years affected. (i) Except as provided in subdivision 
(ii) of this subparagraph, a foreign private foundation described in 
paragraph (b) of this section shall be denied exemption from taxation 
under section 501(a) by reason of subparagraph (1) of this paragraph for 
all taxable years beginning with the taxable year during which it is 
notified by the Commissioner that it has engaged in a prohibited 
transaction. The Commissioner shall publish such notice in the Federal 
Register on the day on

[[Page 216]]

which he so notifies such foreign private foundation. In the case of an 
act or failure to act (without regard to section 4942(e)) which would 
result in a penalty under section 6684(1) if the foreign private 
foundation were a domestic private foundation, before giving notice 
under this subdivision the Commissioner shall warn such foreign private 
foundation that such act or failure to act may be treated as a 
prohibited transaction. However, such act or failure to act will not be 
treated as a prohibited transaction if it is corrected (within the 
meaning of Chapter 42 and the regulations thereunder) within 90 days 
after the making of such warning.
    (ii)(a) Any foreign private foundation described in paragraph (b) of 
this section which is denied exemption from taxation under section 
501(a) by reason of subparagraph (1) of this paragraph may, with respect 
to the second taxable year following the taxable year in which notice is 
given under subdivision (i) of this subparagraph (or any taxable year 
subsequent to such second taxable year), file a request for exemption 
from taxation under section 501(a) on Form 1023. In addition to the 
information generally required of an organization requesting exemption 
as an organization described in section 501(a), a request under this 
subdivision must contain or have attached to it a written declaration, 
made under the penalties of perjury, by a principal officer of such 
organization authorized to make such declaration, that the organization 
will not knowingly again engage in a prohibited transaction.
    (b) If the Commissioner is satisfied that such organization will not 
knowingly again engage in a prohibited transaction and that the 
organization has satisfied all other requirements under section 501, the 
organization will be so notified in writing. In such case the 
organization shall not, with respect to taxable years beginning with the 
taxable year with respect to which a request under this subdivision is 
filed, be denied exemption from taxation under section 501(a) by reason 
of any prohibited transaction which was engaged in before the date on 
which notice was given under subdivision (i) of this subparagraph. 
Section 4948(c) provides that an organization denied exemption under 
such section will not be exempt from taxation under section 501(a) for 
the taxable year in which notice of loss of exemption is given and at 
least one immediately subsequent taxable year.
    (d) Disallowance of certain charitable deductions. No gift, bequest, 
legacy, devise, or transfer shall be allowed as a deduction under 
section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522, if 
made:
    (1) To a foreign private foundation described in paragraph (b) of 
this section after the date on which the Commissioner publishes notice 
under paragraph (c)(3)(i) of this section that he has notified such 
organization that it has engaged in a prohibited transaction, and
    (2) In a taxable year of such organization for which it is not 
exempt from taxation under section 501(a) by reason of paragraph (c)(1) 
of this section.

For purposes of this paragraph, a bequest, legacy, devise, or transfer 
under section 2055 or 2106(a)(2) shall be treated as made on the date of 
death of the decedent. For example, assume that an individual gives 
money to a foreign private foundation described in section 4948(b) in 
January 1970, January 1971, and January 1972. The organization has a 
taxable year from June 1 through May 31. In February 1970, notice is 
duly published that the foreign organization has engaged in a prohibited 
transaction. In December 1970, the organization duly submits a request 
for exemption under paragraph (c)(3)(ii)(a) of this section which is 
granted for the taxable year ending May 31, 1972. The January 1970 gift 
is allowable as a deduction under section 2522 since it was made before 
the notice (February 1970). The January 1971 gift is not allowable as a 
deduction because the taxable year ending May 31, 1971, is a nonexempt 
year (the first taxable year subsequent to the taxable year of the 
notice) for the foreign organization. The January 1972 gift is allowable 
as a deduction under section 2522 because the taxable year ending May 
31, 1972, is an exempt year for the organization.

[T.D. 7218, 37 FR 23918, Nov. 10, 1972; 37 FR 24748, Nov. 21, 1972; 38 
FR 4324, Feb. 13, 1973]

[[Page 217]]



             Subpart J_Black Lung Benefit Trust Excise Taxes

    Source: T.D. 7644, 44 FR 52198, Sept. 7, 1979, unless otherwise 
noted.



Sec. 53.4951-1  Black lung trusts--taxes on self-dealing.

    (a) In general. Section 4951 contains provisions that correspond to 
provisions of section 4941 (relating to taxes on foundation self-
dealing) and section 4946 (relating to definitions and special rules). 
Regulations and rulings under these corresponding provisions apply to 
section 4951 where appropriate.
    (b) Transfer of property to trust. A transfer of personal property 
without consideration to a trust for which a deduction is allowable 
under section 192 does not constitute a sale or exchange for purposes of 
section 4951 unless the property is subject to a mortgage or similar 
lien within section 4951(d)(2)(A). The transfer to a trust of a note or 
other evidence of indebtedness constitutes an extension of credit to the 
obligor for purposes of section 4951(d)(1)(B).
    (c) Deposits. A time or demand deposit made with a bank or credit 
union that is a trustee or other disqualified person with respect to a 
trust constitutes a lending of money for purposes of section 
4951(d)(1)(B) even though the deposit is of a kind generally authorized 
for investments by the trust.
    (d) Trustee. The term ``trustee'' as used in section 4951(e)(5)(B) 
includes any person having powers or responsibilities with respect to a 
trust similar to those of trustees.
    (e) Misallocation of insurance premium. Under section 
501(c)(21)(A)(ii) and Sec. 1.501(c)(21)-1(d), a trust may pay a portion 
of a premium for insurance which covers both black lung liabilities and 
other liabilities, so long as the requirements of section 
501(c)(21)(A)(i) concerning allocation of the total premium are met. 
However, if an insurance company misallocates the total premium in a 
manner which benefits a disqualified person, the amount of misallocation 
constitutes a use of trust assets for the benefit of the disqualified 
person within section 4951(d)(1)(D). For these purposes, it is 
irrelevant whether the combination of insurance is sold under one policy 
or more than one policy.
    (f) Effective date. Section 4951 applies with respect to acts that 
occur after December 31, 1977, in and for trust taxable years beginning 
after December 31, 1977.



Sec. 53.4952-1  Black lung trusts--taxes on taxable expenditures.

    (a) In general. Section 4952 contains provisions that generally 
correspond to provisions of section 4945 (relating to taxes on taxable 
expenditures by private foundations) and section 4946 (relating to 
definitions and special rules). Regulations and rulings under these 
corresponding provisions apply to section 4952 where appropriate. See 
section 4952(e)(1) for the definition of correction.
    (b) Unauthorized investments. The term ``taxable expenditure'' in 
section 4952(d) includes an investment that is not authorized under 
section 501(c)(21)(B)(ii).
    (c) Effective date. Section 4952 applies with respect to 
expenditures made after December 31, 1977, in and for trust taxable 
years beginning after December 31, 1977.



                   Subpart K_Second Tier Excise Taxes

    Source: T.D. 8084, 51 FR 16303, May 2, 1986, unless otherwise noted.



Sec. 53.4955-1  Tax on political expenditures.

    (a) Relationship between section 4955 excise taxes and substantive 
standards for exemption under section 501(c)(3). The excise taxes 
imposed by section 4955 do not affect the substantive standards for tax 
exemption under section 501(c)(3), under which an organization is 
described in section 501(c)(3) only if it does not participate or 
intervene in any political campaign on behalf of any candidate for 
public office.
    (b) Imposition of initial taxes on organization managers--(1) In 
general. The excise tax under section 4955(a)(2) on the agreement of any 
organization manager to the making of a political expenditure by a 
section 501(c)(3) organization is imposed only in cases where--

[[Page 218]]

    (i) A tax is imposed by section 4955(a)(1);
    (ii) The organization manager knows that the expenditure to which 
the manager agrees is a political expenditure; and
    (iii) The agreement is willful and is not due to reasonable cause.
    (2) Type of organization managers covered--(i) In general. The tax 
under section 4955(a)(2) is imposed only on those organization managers 
who are authorized to approve, or to exercise discretion in recommending 
approval of, the making of the expenditure by the organization and on 
those organization managers who are members of a group (such as the 
organization's board of directors or trustees) which is so authorized.
    (ii) Officer. For purposes of section 4955(f)(2)(A), a person is an 
officer of an organization if--
    (A) That person is specifically so designated under the certificate 
of incorporation, bylaws, or other constitutive documents of the 
foundation; or
    (B) That person regularly exercises general authority to make 
administrative or policy decisions on behalf of the organization. 
Independent contractors, acting in a capacity as attorneys, accountants, 
and investment managers and advisors, are not officers. With respect to 
any expenditure, any person described in this paragraph (b)(2)(ii)(B) 
who has authority merely to recommend particular administrative or 
policy decisions, but not to implement them without approval of a 
superior, is not an officer.
    (iii) Employee. For purposes of section 4955(f)(2)(B), an individual 
rendering services to an organization is an employee of the organization 
only if that individual is an employee within the meaning of section 
3121(d)(2). With respect to any expenditure, an employee (other than an 
officer, director, or trustee of the organization) is described in 
section 4955(f)(2)(B) only if he or she has final authority or 
responsibility (either officially or effectively) with respect to such 
expenditure.
    (3) Type of agreement required. An organization manager agrees to 
the making of a political expenditure if the manager manifests approval 
of the expenditure which is sufficient to constitute an exercise of the 
organization manager's authority to approve, or to exercise discretion 
in recommending approval of, the making of the expenditure by the 
organization. The manifestation of approval need not be the final or 
decisive approval on behalf of the organization.
    (4) Knowing--(i) General rule. For purposes of section 4955, an 
organization manager is considered to have agreed to an expenditure 
knowing that it is a political expenditure only if--
    (A) The manager has actual knowledge of sufficient facts so that, 
based solely upon these facts, the expenditure would be a political 
expenditure;
    (B) The manager is aware that such an expenditure under these 
circumstances may violate the provisions of federal tax law governing 
political expenditures; and
    (C) The manager negligently fails to make reasonable attempts to 
ascertain whether the expenditure is a political expenditure, or the 
manager is aware that it is a political expenditure.
    (ii) Amplification of general rule. For purposes of section 4955, 
knowing does not mean having reason to know. However, evidence tending 
to show that an organization manager has reason to know of a particular 
fact or particular rule is relevant in determining whether the manager 
had actual knowledge of the fact or rule. Thus, for example, evidence 
tending to show that an organization manager has reason to know of 
sufficient facts so that, based solely upon those facts, an expenditure 
would be a political expenditure is relevant in determining whether the 
manager has actual knowledge of the facts.
    (5) Willful. An organization manager's agreement to a political 
expenditure is willful if it is voluntary, conscious, and intentional. 
No motive to avoid the restrictions of the law or the incurrence of any 
tax is necessary to make an agreement willful. However, an organization 
manager's agreement to a political expenditure is not willful if the 
manager does not know that it is a political expenditure.
    (6) Due to reasonable cause. An organization manager's actions are 
due to

[[Page 219]]

reasonable cause if the manager has exercised his or her responsibility 
on behalf of the organization with ordinary business care and prudence.
    (7) Advice of counsel. An organization manager's agreement to an 
expenditure is ordinarily not considered knowing or willful and is 
ordinarily considered due to reasonable cause if the manager, after full 
disclosure of the factual situation to legal counsel (including house 
counsel), relies on the advice of counsel expressed in a reasoned 
written legal opinion that an expenditure is not a political expenditure 
under section 4955 (or that expenditures conforming to certain 
guidelines are not political expenditures). For this purpose, a written 
legal opinion is considered reasoned even if it reaches a conclusion 
which is subsequently determined to be incorrect, so long as the opinion 
addresses itself to the facts and applicable law. A written legal 
opinion is not considered reasoned if it does nothing more than recite 
the facts and express a conclusion. However, the absence of advice of 
counsel with respect to an expenditure does not, by itself, give rise to 
any inference that an organization manager agreed to the making of the 
expenditure knowingly, willfully, or without reasonable cause.
    (8) Cross reference. For provisions relating to the burden of proof 
in cases involving the issue of whether an organization manager has 
knowingly agreed to the making of a political expenditure, see section 
7454(b).
    (c) Amplification of political expenditure definition--(1) General 
rule. Any expenditure that would cause an organization that makes the 
expenditure to be classified as an action organization by reason of 
Sec. 1.501(c)(3)-1(c)(3)(iii) of this chapter is a political 
expenditure within the meaning of section 4955(d)(1).
    (2) Other political expenditures--(i) For purposes of section 
4955(d)(2), an organization is effectively controlled by a candidate or 
prospective candidate only if the individual has a continuing, 
substantial involvement in the day-to-day operations or management of 
the organization. An organization is not effectively controlled by a 
candidate or a prospective candidate merely because it is affiliated 
with the candidate, or merely because the candidate knows the directors, 
officers, or employees of the organization. The effectively controlled 
test is not met merely because the organization carries on its research, 
study, or other educational activities with respect to subject matter or 
issues in which the individual is interested or with which the 
individual is associated.
    (ii) For purposes of section 4955(d)(2), a determination of whether 
the primary purpose of an organization is promoting the candidacy or 
prospective candidacy of an individual for public office is made on the 
basis of all the facts and circumstances. The factors to be considered 
include whether the surveys, studies, materials, etc. prepared by the 
organization are made available only to the candidate or are made 
available to the general public; and whether the organization pays for 
speeches and travel expenses for only one individual, or for speeches or 
travel expenses of several persons. The fact that a candidate or 
prospective candidate utilizes studies, papers, materials, etc., 
prepared by the organization (such as in a speech by the candidate) is 
not to be considered as a factor indicating that the organization has a 
purpose of promoting the candidacy or prospective candidacy of that 
individual where such studies, papers, materials, etc. are not made 
available only to that individual.
    (iii) Expenditures for voter registration, voter turnout, or voter 
education constitute other expenses, treated as political expenditures 
by reason of section 4955(d)(2)(E), only if the expenditures violate the 
prohibition on political activity provided in section 501(c)(3).
    (d) Abatement, refund, or no assessment of initial tax. No initial 
(first-tier) tax will be imposed under section 4955(a), or the initial 
tax will be abated or refunded, if the organization or an organization 
manager establishes to the satisfaction of the IRS that--
    (1) The political expenditure was not willful and flagrant; and
    (2) The political expenditure was corrected.
    (e) Correction--(1) Recovery of expenditure. For purposes of section 
4955(f)(3)

[[Page 220]]

and this section, correction of a political expenditure is accomplished 
by recovering part or all of the expenditure to the extent recovery is 
possible, and, where full recovery cannot be accomplished, by any 
additional corrective action which the Commissioner may prescribe. The 
organization making the political expenditure is not under any 
obligation to attempt to recover the expenditure by legal action if the 
action would in all probability not result in the satisfaction of 
execution on a judgment.
    (2) Establishing safeguards. Correction of a political expenditure 
must also involve the establishment of sufficient safeguards to prevent 
future political expenditures by the organization. The determination of 
whether safeguards are sufficient to prevent future political 
expenditures by the organization is made by the District Director.
    (f) Effective date. This section is effective December 5, 1995.

[T.D. 8628, 60 FR 62210, Dec. 5, 1995]



Sec. 53.4958-0  Table of contents.

    This section lists the major captions contained in Sec. Sec. 
53.4958-1 through 53.4958-8.

          Sec. 53.4958-1 Taxes on excess benefit transactions

(a) In general.
(b) Excess benefit defined.
(c) Taxes paid by disqualified person.
(1) Initial tax.
(2) Additional tax on disqualified person.
(i) In general.
(ii) Taxable period.
(iii) Abatement if correction during the correction period.
(d) Tax paid by organization managers.
(1) In general.
(2) Organization manager defined.
(i) In general.
(ii) Special rule for certain committee members.
(3) Participation.
(4) Knowing.
(i) In general.
(ii) Amplification of general rule.
(iii) Reliance on professional advice.
(iv) Satisfaction of rebuttable presumption of reasonableness.
(5) Willful.
(6) Due to reasonable cause.
(7) Limits on liability for management.
(8) Joint and several liability.
(9) Burden of proof.
(e) Date of occurrence.
(1) In general.
(2) Special rules.
(3) Statute of limitations rules.
(f) Effective date for imposition of taxes.
(1) In general.
(2) Existing binding contracts.

    Sec. 53.4958-2 Definition of applicable tax-exempt organization

(a) Organizations described in section 501(c)(3) or (4) and exempt from 
          tax under section 501(a).
(1) In general.
(2) Exceptions from definition of applicable tax-exempt organization.
(i) Private foundation.
(ii) Governmental unit or affiliate.
(3) Organizations described in section 501(c)(3).
(4) Organizations described in section 501(c)(4).
(5) Effect of non-recognition or revocation of exempt status.
(b) Special rules.
(1) Transition rule for lookback period.
(2) Certain foreign organizations.

            Sec. 53.4958-3 Definition of disqualified person

(a) In general.
(1) Scope of definition.
(2) Transition rule for lookback period.
(b) Statutory categories of disqualified persons.
(1) Family members.
(2) Thirty-five percent controlled entities.
(i) In general.
(ii) Combined voting power.
(iii) Constructive ownership rules.
(A) Stockholdings.
(B) Profits or beneficial interest.
(c) Persons having substantial influence.
(1) Voting members of the governing body.
(2) Presidents, chief executive officers, or chief operating officers.
(3) Treasurers and chief financial officers.
(4) Persons with a material financial interest in a provider-sponsored 
          organization.
(d) Persons deemed not to have substantial influence.
(1) Tax-exempt organizations described in section 501(c)(3).
(2) Certain section 501(c)(4) organizations.
(3) Employees receiving economic benefits of less than a specified 
          amount in a taxable year.
(e) Facts and circumstances govern in all other cases.
(1) In general.
(2) Facts and circumstances tending to show substantial influence.
(3) Facts and circumstances tending to show no substantial influence.
(f) Affiliated organizations.
(g) Examples.

               Sec. 53.4958-4 Excess benefit transaction

(a) Definition of excess benefit transaction.

[[Page 221]]

(1) In general.
(2) Economic benefit provided indirectly.
(i) In general.
(ii) Through a controlled entity.
(A) In general.
(B) Definition of control.
(1) In general.
(2) Constructive ownership.
(iii) Through an intermediary.
(iv) Examples.
(3) Exception for fixed payments made pursuant to an initial contract.
(i) In general.
(ii) Fixed payment.
(A) In general.
(B) Special rules.
(iii) Initial contract.
(iv) Substantial performance required.
(v) Treatment as a new contract.
(vi) Evaluation of non-fixed payments.
(vii) Examples.
(4) Certain economic benefits disregarded for purposes of section 4958.
(i) Nontaxable fringe benefits.
(ii) Expense reimbursement payments pursuant to accountable plans.
(iii) Certain economic benefits provided to a volunteer for the 
          organization.
(iv) Certain economic benefits provided to a member of, or donor to, the 
          organization.
(v) Economic benefits provided to a charitable beneficiary.
(vi) Certain economic benefits provided to a governmental unit.
(5) Exception for certain payments made pursuant to an exemption granted 
          by the Department of Labor under ERISA.
(b) Valuation standards.
(1) In general.
(i) Fair market value of property.
(ii) Reasonable compensation.
(A) In general.
(B) Items included in determining the value of compensation for purposes 
          of determining reasonableness under section 4958.
(C) Inclusion in compensation for reasonableness determination does not 
          govern income tax treatment.
(2) Timing of reasonableness determination.
(i) In general.
(ii) Treatment as a new contract.
(iii) Examples.
(c) Establishing intent to treat economic benefit as consideration for 
          the performance of services.
(1) In general.
(2) Nontaxable benefits.
(3) Contemporaneous substantiation.
(i) Reporting of benefit.
(A) In general.
(B) Failure to report due to reasonable cause.
(ii) Other written contemporaneous evidence.
(4) Examples.

Sec. 53.4958-5 Transaction in which the amount of the economic benefit 
    is determined in whole or in part by the revenues of one or more 
               activities of the organization. [Reserved]

  Sec. 53.4958-6 Rebuttable presumption that a transaction is not an 
                       excess benefit transaction.

(a) In general.
(b) Rebutting the presumption.
(c) Requirements for invoking rebuttable presumption.
(1) Approval by an authorized body.
(i) In general.
(ii) Individuals not included on authorized body.
(iii) Absence of conflict of interest.
(2) Appropriate data as to comparability.
(i) In general.
(ii) Special rule for compensation paid by small organizations.
(iii) Application of special rule for small organizations.
(iv) Examples.
(3) Documentation.
(d) No presumption with respect to non-fixed payments until amounts are 
          determined.
(1) In general.
(2) Special rule for certain non-fixed payments subject to a cap.
(e) No inference from absence of presumption.
(f) Period of reliance on rebuttable presumption.

                       Sec. 53.4958-7 Correction.

(a) In general.
(b) Form of correction.
(1) Cash or cash equivalents.
(2) Anti-abuse rule.
(3) Special rule relating to nonqualified deferred compensation.
(4) Return of specific property.
(i) In general.
(ii) Payment not equal to correction amount.
(iii) Disqualified person may not participate in decision.
(c) Correction amount.
(d) Correction where contract has been partially performed.
(e) Correction in the case of an applicable tax-exempt organization that 
          has ceased to exist, or is no longer tax-exempt.
(1) In general.
(2) Section 501(c)(3) organizations.
(3) Section 501(c)(4) organizations.
(f) Examples.

                     Sec. 53.4958-8 Special rules.

(a) Substantive requirements for exemption still apply.
(b) Interaction between section 4958 and section 7611 rules for church 
          tax inquiries and examinations.
(c) Other substantiation requirements.

[T.D. 8978, 67 FR 3083, Jan. 23, 2002]

[[Page 222]]



Sec. 53.4958-1  Taxes on excess benefit transactions.

    (a) In general. Section 4958 imposes excise taxes on each excess 
benefit transaction (as defined in section 4958(c) and Sec. 53.4958-4) 
between an applicable tax-exempt organization (as defined in section 
4958(e) and Sec. 53.4958-2) and a disqualified person (as defined in 
section 4958(f)(1) and Sec. 53.4958-3). A disqualified person who 
receives an excess benefit from an excess benefit transaction is liable 
for payment of a section 4958(a)(1) excise tax equal to 25 percent of 
the excess benefit. If an initial tax is imposed by section 4958(a)(1) 
on an excess benefit transaction and the transaction is not corrected 
(as defined in section 4958(f)(6) and Sec. 53.4958-7) within the 
taxable period (as defined in section 4958(f)(5) and paragraph 
(c)(2)(ii) of this section), then any disqualified person who received 
an excess benefit from the excess benefit transaction on which the 
initial tax was imposed is liable for an additional tax of 200 percent 
of the excess benefit. An organization manager (as defined in section 
4958(f)(2) and paragraph (d) of this section) who participates in an 
excess benefit transaction, knowing that it was such a transaction, is 
liable for payment of a section 4958(a)(2) excise tax equal to 10 
percent of the excess benefit, unless the participation was not willful 
and was due to reasonable cause. If an organization manager also 
receives an excess benefit from an excess benefit transaction, the 
manager may be liable for both taxes imposed by section 4958(a).
    (b) Excess benefit defined. An excess benefit is the amount by which 
the value of the economic benefit provided by an applicable tax-exempt 
organization directly or indirectly to or for the use of any 
disqualified person exceeds the value of the consideration (including 
the performance of services) received for providing such benefit.
    (c) Taxes paid by disqualified person--(1) Initial tax. Section 
4958(a)(1) imposes a tax equal to 25 percent of the excess benefit on 
each excess benefit transaction. The section 4958(a)(1) tax shall be 
paid by any disqualified person who received an excess benefit from that 
excess benefit transaction. With respect to any excess benefit 
transaction, if more than one disqualified person is liable for the tax 
imposed by section 4958(a)(1), all such persons are jointly and 
severally liable for that tax.
    (2) Additional tax on disqualified person--(i) In general. Section 
4958(b) imposes a tax equal to 200 percent of the excess benefit in any 
case in which section 4958(a)(1) imposes a 25-percent tax on an excess 
benefit transaction and the transaction is not corrected (as defined in 
section 4958(f)(6) and Sec. 53.4958-7) within the taxable period (as 
defined in section 4958(f)(5) and paragraph (c)(2)(ii) of this section). 
If a disqualified person makes a payment of less than the full 
correction amount under the rules of Sec. 53.4958-7, the 200-percent 
tax is imposed only on the unpaid portion of the correction amount (as 
described in Sec. 53.4958-7(c)). The tax imposed by section 4958(b) is 
payable by any disqualified person who received an excess benefit from 
the excess benefit transaction on which the initial tax was imposed by 
section 4958(a)(1). With respect to any excess benefit transaction, if 
more than one disqualified person is liable for the tax imposed by 
section 4958(b), all such persons are jointly and severally liable for 
that tax.
    (ii) Taxable period. Taxable period means, with respect to any 
excess benefit transaction, the period beginning with the date on which 
the transaction occurs and ending on the earlier of--
    (A) The date of mailing a notice of deficiency under section 6212 
with respect to the section 4958(a)(1) tax; or
    (B) The date on which the tax imposed by section 4958(a)(1) is 
assessed.
    (iii) Abatement if correction during the correction period. For 
rules relating to abatement of taxes on excess benefit transactions that 
are corrected within the correction period, as defined in section 
4963(e), see sections 4961(a), 4962(a), and the regulations thereunder. 
The abatement rules of section 4961 specifically provide for a 90-day 
correction period after the date of mailing a notice of deficiency under 
section 6212 with respect to the section 4958(b) 200-percent tax. If the 
excess benefit is corrected during that correction period, the 200-
percent tax imposed shall not be assessed, and if assessed the 
assessment shall be abated, and if collected

[[Page 223]]

shall be credited or refunded as an overpayment. For special rules 
relating to abatement of the 25-percent tax, see section 4962.
    (d) Tax paid by organization managers--(1) In general. In any case 
in which section 4958(a)(1) imposes a tax, section 4958(a)(2) imposes a 
tax equal to 10 percent of the excess benefit on the participation of 
any organization manager who knowingly participated in the excess 
benefit transaction, unless such participation was not willful and was 
due to reasonable cause. Any organization manager who so participated in 
the excess benefit transaction must pay the tax.
    (2) Organization manager defined--(i) In general. An organization 
manager is, with respect to any applicable tax-exempt organization, any 
officer, director, or trustee of such organization, or any individual 
having powers or responsibilities similar to those of officers, 
directors, or trustees of the organization, regardless of title. A 
person is an officer of an organization if that person--
    (A) Is specifically so designated under the certificate of 
incorporation, by-laws, or other constitutive documents of the 
organization; or
    (B) Regularly exercises general authority to make administrative or 
policy decisions on behalf of the organization. A contractor who acts 
solely in a capacity as an attorney, accountant, or investment manager 
or advisor, is not an officer. For purposes of this paragraph 
(d)(2)(i)(B), any person who has authority merely to recommend 
particular administrative or policy decisions, but not to implement them 
without approval of a superior, is not an officer.
    (ii) Special rule for certain committee members. An individual who 
is not an officer, director, or trustee, yet serves on a committee of 
the governing body of an applicable tax-exempt organization (or as a 
designee of the governing body described in Sec. 53.4958-6(c)(1)) that 
is attempting to invoke the rebuttable presumption of reasonableness 
described in Sec. 53.4958-6 based on the committee's (or designee's) 
actions, is an organization manager for purposes of the tax imposed by 
section 4958(a)(2).
    (3) Participation. For purposes of section 4958(a)(2) and this 
paragraph (d), participation includes silence or inaction on the part of 
an organization manager where the manager is under a duty to speak or 
act, as well as any affirmative action by such manager. An organization 
manager is not considered to have participated in an excess benefit 
transaction, however, where the manager has opposed the transaction in a 
manner consistent with the fulfillment of the manager's responsibilities 
to the applicable tax-exempt organization.
    (4) Knowing--(i) In general. For purposes of section 4958(a)(2) and 
this paragraph (d), a manager participates in a transaction knowingly 
only if the person--
    (A) Has actual knowledge of sufficient facts so that, based solely 
upon those facts, such transaction would be an excess benefit 
transaction;
    (B) Is aware that such a transaction under these circumstances may 
violate the provisions of Federal tax law governing excess benefit 
transactions; and
    (C) Negligently fails to make reasonable attempts to ascertain 
whether the transaction is an excess benefit transaction, or the manager 
is in fact aware that it is such a transaction.
    (ii) Amplification of general rule. Knowing does not mean having 
reason to know. However, evidence tending to show that a manager has 
reason to know of a particular fact or particular rule is relevant in 
determining whether the manager had actual knowledge of such a fact or 
rule. Thus, for example, evidence tending to show that a manager has 
reason to know of sufficient facts so that, based solely upon such 
facts, a transaction would be an excess benefit transaction is relevant 
in determining whether the manager has actual knowledge of such facts.
    (iii) Reliance on professional advice. An organization manager's 
participation in a transaction is ordinarily not considered knowing 
within the meaning of section 4958(a)(2), even though the transaction is 
subsequently held to be an excess benefit transaction, to the extent 
that, after full disclosure of the factual situation to an appropriate 
professional, the organization manager relies on a reasoned written 
opinion of

[[Page 224]]

that professional with respect to elements of the transaction within the 
professional's expertise. For purposes of section 4958(a)(2) and this 
paragraph (d), a written opinion is reasoned even though it reaches a 
conclusion that is subsequently determined to be incorrect so long as 
the opinion addresses itself to the facts and the applicable standards. 
However, a written opinion is not reasoned if it does nothing more than 
recite the facts and express a conclusion. The absence of a written 
opinion of an appropriate professional with respect to a transaction 
shall not, by itself, however, give rise to any inference that an 
organization manager participated in the transaction knowingly. For 
purposes of this paragraph, appropriate professionals on whose written 
opinion an organization manager may rely, are limited to--
    (A) Legal counsel, including in-house counsel;
    (B) Certified public accountants or accounting firms with expertise 
regarding the relevant tax law matters; and
    (C) Independent valuation experts who--
    (1) Hold themselves out to the public as appraisers or compensation 
consultants;
    (2) Perform the relevant valuations on a regular basis;
    (3) Are qualified to make valuations of the type of property or 
services involved; and
    (4) Include in the written opinion a certification that the 
requirements of paragraphs (d)(4)(iii)(C)(1) through (3) of this section 
are met.
    (iv) Satisfaction of rebuttable presumption of reasonableness. An 
organization manager's participation in a transaction is ordinarily not 
considered knowing within the meaning of section 4958(a)(2), even though 
the transaction is subsequently held to be an excess benefit 
transaction, if the appropriate authorized body has met the requirements 
of Sec. 53.4958-6(a) with respect to the transaction.
    (5) Willful. For purposes of section 4958(a)(2) and this paragraph 
(d), participation by an organization manager is willful if it is 
voluntary, conscious, and intentional. No motive to avoid the 
restrictions of the law or the incurrence of any tax is necessary to 
make the participation willful. However, participation by an 
organization manager is not willful if the manager does not know that 
the transaction in which the manager is participating is an excess 
benefit transaction.
    (6) Due to reasonable cause. An organization manager's participation 
is due to reasonable cause if the manager has exercised responsibility 
on behalf of the organization with ordinary business care and prudence.
    (7) Limits on liability for management. The maximum aggregate amount 
of tax collectible under section 4958(a)(2) and this paragraph (d) from 
organization managers with respect to any one excess benefit transaction 
is $10,000.
    (8) Joint and several liability. In any case where more than one 
person is liable for a tax imposed by section 4958(a)(2), all such 
persons shall be jointly and severally liable for the taxes imposed 
under section 4958(a)(2) with respect to that excess benefit 
transaction.
    (9) Burden of proof. For provisions relating to the burden of proof 
in cases involving the issue of whether an organization manager has 
knowingly participated in an excess benefit transaction, see section 
7454(b) and Sec. 301.7454-2 of this chapter. In these cases, the 
Commissioner bears the burden of proof.
    (e) Date of occurrence--(1) In general. Except as otherwise 
provided, an excess benefit transaction occurs on the date on which the 
disqualified person receives the economic benefit for Federal income tax 
purposes. When a single contractual arrangement provides for a series of 
compensation or other payments to (or for the use of) a disqualified 
person over the course of the disqualified person's taxable year (or 
part of a taxable year), any excess benefit transaction with respect to 
these aggregate payments is deemed to occur on the last day of the 
taxable year (or if the payments continue for part of the year, the date 
of the last payment in the series).
    (2) Special rules. In the case of benefits provided pursuant to a 
qualified pension, profit-sharing, or stock bonus plan, the transaction 
occurs on the date the benefit is vested. In the case of a transfer of 
property that is subject

[[Page 225]]

to a substantial risk of forfeiture or in the case of rights to future 
compensation or property (including benefits under a nonqualified 
deferred compensation plan), the transaction occurs on the date the 
property, or the rights to future compensation or property, is not 
subject to a substantial risk of forfeiture. However, where the 
disqualified person elects to include an amount in gross income in the 
taxable year of transfer pursuant to section 83(b), the general rule of 
paragraph (e)(1) of this section applies to the property with respect to 
which the section 83(b) election is made. Any excess benefit transaction 
with respect to benefits under a deferred compensation plan which vest 
during any taxable year of the disqualified person is deemed to occur on 
the last day of such taxable year. For the rules governing the timing of 
the reasonableness determination for deferred, contingent, and certain 
other noncash compensation, see Sec. 53.4958-4(b)(2).
    (3) Statute of limitations rules. See sections 6501(e)(3) and (l) 
and the regulations thereunder for statute of limitations rules as they 
apply to section 4958 excise taxes.
    (f) Effective date for imposition of taxes--(1) In general. The 
section 4958 taxes imposed on excess benefit transactions or on 
participation in excess benefit transactions apply to transactions 
occurring on or after September 14, 1995.
    (2) Existing binding contracts. The section 4958 taxes do not apply 
to any transaction occurring pursuant to a written contract that was 
binding on September 13, 1995, and at all times thereafter before the 
transaction occurs. A written binding contract that is terminable or 
subject to cancellation by the applicable tax-exempt organization 
without the disqualified person's consent (including as the result of a 
breach of contract by the disqualified person) and without substantial 
penalty to the organization, is no longer treated as a binding contract 
as of the earliest date that any such termination or cancellation, if 
made, would be effective. If a binding written contract is materially 
changed, it is treated as a new contract entered into as of the date the 
material change is effective. A material change includes an extension or 
renewal of the contract (other than an extension or renewal that results 
from the person contracting with the applicable tax-exempt organization 
unilaterally exercising an option expressly granted by the contract), or 
a more than incidental change to any payment under the contract.

[T.D. 8978, 67 FR 3083, Jan. 23, 2002]



Sec. 53.4958-2  Definition of applicable tax-exempt organization.

    (a) Organizations described in section 501(c)(3) or (4) and exempt 
from tax under section 501(a)--(1) In general. An applicable tax-exempt 
organization is any organization that, without regard to any excess 
benefit, would be described in section 501(c)(3) or (4) and exempt from 
tax under section 501(a). An applicable tax-exempt organization also 
includes any organization that was described in section 501(c)(3) or (4) 
and was exempt from tax under section 501(a) at any time during a five-
year period ending on the date of an excess benefit transaction (the 
lookback period).
    (2) Exceptions from definition of applicable tax-exempt 
organization--(i) Private foundation. A private foundation as defined in 
section 509(a) is not an applicable tax-exempt organization for section 
4958 purposes.
    (ii) Governmental unit or affiliate. A governmental unit or an 
affiliate of a governmental unit is not an applicable tax-exempt 
organization for section 4958 purposes if it is--
    (A) Exempt from (or not subject to) taxation without regard to 
section 501(a); or
    (B) Relieved from filing an annual return pursuant to the authority 
of Sec. 1.6033-2(g)(6).
    (3) Organizations described in section 501(c)(3). An organization is 
described in section 501(c)(3) for purposes of section 4958 only if the 
organization--
    (i) Provides the notice described in section 508; or
    (ii) Is described in section 501(c)(3) and specifically is excluded 
from the requirements of section 508 by that section.
    (4) Organizations described in section 501(c)(4). An organization is 
described

[[Page 226]]

in section 501(c)(4) for purposes of section 4958 only if the 
organization--
    (i) Has applied for and received recognition from the Internal 
Revenue Service as an organization described in section 501(c)(4); or
    (ii) Has filed an application for recognition under section 
501(c)(4) with the Internal Revenue Service, has filed an annual 
information return as a section 501(c)(4) organization under the 
Internal Revenue Code or regulations promulgated thereunder, or has 
otherwise held itself out as being described in section 501(c)(4) and 
exempt from tax under section 501(a).
    (5) Effect of non-recognition or revocation of exempt status. An 
organization is not described in paragraph (a)(3) or (4) of this section 
during any period covered by a final determination or adjudication that 
the organization is not exempt from tax under section 501(a) as an 
organization described in section 501(c)(3) or (4), so long as that 
determination or adjudication is not based upon participation in 
inurement or one or more excess benefit transactions. However, the 
organization may be an applicable tax-exempt organization for that 
period as a result of the five-year lookback period described in 
paragraph (a)(1) of this section.
    (6) Examples. The following examples illustrate the principles of 
this section, which defines an applicable tax-exempt organization for 
purposes of section 4958:

    Example 1. O is a nonprofit corporation formed under state law. O 
filed its application for recognition of exemption under section 
501(c)(3) within the time prescribed under section 508(a). In its 
application, O described its plans for purchasing property from some of 
its directors at prices that would exceed fair market value. After 
reviewing the application, the IRS determined that because of the 
proposed property purchase transactions, O failed to establish that it 
met the requirements for an organization described in section 501(c)(3). 
Accordingly, the IRS denied O's application. While O's application was 
pending, O engaged in the purchase transactions described in its 
application at prices that exceeded the fair market values of the 
properties. Although these transactions would constitute excess benefit 
transactions under section 4958, because the IRS never recognized O as 
an organization described in section 501(c)(3), O was never an 
applicable tax-exempt organization under section 4958. Therefore, these 
transactions are not subject to the excise taxes provided in section 
4958.
    Example 2. O is a nonprofit corporation formed under state law. O 
files its application for recognition of exemption under section 
501(c)(3) within the time prescribed under section 508(a). The IRS 
issues a favorable determination letter in Year 1 that recognizes O as 
an organization described in section 501(c)(3). Subsequently, in Year 5 
of O's operations, O engages in certain transactions that constitute 
excess benefit transactions under section 4958 and violate the 
proscription against inurement under section 501(c)(3) and Sec. 
1.501(c)(3)-1(c)(2). The IRS examines the Form 990, ``Return of 
Organization Exempt From Income Tax'', that O filed for Year 5. After 
considering all the relevant facts and circumstances in accordance with 
Sec. 1.501(c)(3)-1(f), the IRS concludes that O is no longer described 
in section 501(c)(3) effective in Year 5. The IRS does not examine the 
Forms 990 that O filed for its first four years of operations and, 
accordingly, does not revoke O's exempt status for those years. Although 
O's tax-exempt status is revoked effective in Year 5, under the lookback 
rules in paragraph (a)(1) of this section and Sec. 53.4958-3(a)(1) of 
this chapter, during the five-year period prior to the excess benefit 
transactions that occurred in Year 5, O was an applicable tax-exempt 
organization and O's directors were disqualified persons as to O. 
Therefore, the transactions between O and its directors during Year 5 
are subject to the applicable excise taxes provided in section 4958.

    (b) Special rules--(1) Transition rule for lookback period. In the 
case of any excess benefit transaction occurring before September 14, 
2000, the lookback period described in paragraph (a)(1) of this section 
begins on September 14, 1995, and ends on the date of the transaction.
    (2) Certain foreign organizations. A foreign organization, 
recognized by the Internal Revenue Service or by treaty, that receives 
substantially all of its support (other than gross investment income) 
from sources outside of the United States is not an organization 
described in section 501(c)(3) or (4) for purposes of section 4958.

[T.D. 8978, 67 FR 3083, Jan. 23, 2002, as amended by T.D. 9390, 73 FR 
16524, Mar. 28, 2008]



Sec. 53.4958-3  Definition of disqualified person.

    (a) In general--(1) Scope of definition. Section 4958(f)(1) defines 
disqualified person, with respect to any transaction,

[[Page 227]]

as any person who was in a position to exercise substantial influence 
over the affairs of an applicable tax-exempt organization at any time 
during the five-year period ending on the date of the transaction (the 
lookback period). Paragraph (b) of this section describes persons who 
are defined to be disqualified persons under the statute, including 
certain family members of an individual in a position to exercise 
substantial influence, and certain 35-percent controlled entities. 
Paragraph (c) of this section describes persons in a position to 
exercise substantial influence over the affairs of an applicable tax-
exempt organization by virtue of their powers and responsibilities or 
certain interests they hold. Paragraph (d) of this section describes 
persons deemed not to be in a position to exercise substantial 
influence. Whether any person who is not described in paragraph (b), (c) 
or (d) of this section is a disqualified person with respect to a 
transaction for purposes of section 4958 is based on all relevant facts 
and circumstances, as described in paragraph (e) of this section. 
Paragraph (f) of this section describes special rules for affiliated 
organizations. Examples in paragraph (g) of this section illustrate 
these categories of persons.
    (2) Transition rule for lookback period. In the case of any excess 
benefit transaction occurring before September 14, 2000, the lookback 
period described in paragraph (a)(1) of this section begins on September 
14, 1995, and ends on the date of the transaction.
    (b) Statutory categories of disqualified persons--(1) Family 
members. A person is a disqualified person with respect to any 
transaction with an applicable tax-exempt organization if the person is 
a member of the family of a person who is a disqualified person 
described in paragraph (a) of this section (other than as a result of 
this paragraph) with respect to any transaction with the same 
organization. For purposes of the following sentence, a legally adopted 
child of an individual is treated as a child of such individual by 
blood. A person's family is limited to--
    (i) Spouse;
    (ii) Brothers or sisters (by whole or half blood);
    (iii) Spouses of brothers or sisters (by whole or half blood);
    (iv) Ancestors;
    (v) Children;
    (vi) Grandchildren;
    (vii) Great grandchildren; and
    (viii) Spouses of children, grandchildren, and great grandchildren.
    (2) Thirty-five percent controlled entities--(i) In general. A 
person is a disqualified person with respect to any transaction with an 
applicable tax-exempt organization if the person is a 35-percent 
controlled entity. A 35-percent controlled entity is--
    (A) A corporation in which persons described in this section (except 
in paragraphs (b)(2) and (d) of this section) own more than 35 percent 
of the combined voting power;
    (B) A partnership in which persons described in this section (except 
in paragraphs (b)(2) and (d) of this section) own more than 35 percent 
of the profits interest; or
    (C) A trust or estate in which persons described in this section 
(except in paragraphs (b)(2) and (d) of this section) own more than 35 
percent of the beneficial interest.
    (ii) Combined voting power. For purposes of this paragraph (b)(2), 
combined voting power includes voting power represented by holdings of 
voting stock, direct or indirect, but does not include voting rights 
held only as a director, trustee, or other fiduciary.
    (iii) Constructive ownership rules--(A) Stockholdings. For purposes 
of section 4958(f)(3) and this paragraph (b)(2), indirect stockholdings 
are taken into account as under section 267(c), except that in applying 
section 267(c)(4), the family of an individual shall include the members 
of the family specified in section 4958(f)(4) and paragraph (b)(1) of 
this section.
    (B) Profits or beneficial interest. For purposes of section 
4958(f)(3) and this paragraph (b)(2), the ownership of profits or 
beneficial interests shall be determined in accordance with the rules 
for constructive ownership of stock provided in section 267(c) (other 
than section 267(c)(3)), except that in applying section 267(c)(4), the 
family of an individual shall include the members of the family 
specified in section 4958(f)(4) and paragraph (b)(1) of this section.

[[Page 228]]

    (c) Persons having substantial influence. A person who holds any of 
the following powers, responsibilities, or interests is in a position to 
exercise substantial influence over the affairs of an applicable tax-
exempt organization:
    (1) Voting members of the governing body. This category includes any 
individual serving on the governing body of the organization who is 
entitled to vote on any matter over which the governing body has 
authority.
    (2) Presidents, chief executive officers, or chief operating 
officers. This category includes any person who, regardless of title, 
has ultimate responsibility for implementing the decisions of the 
governing body or for supervising the management, administration, or 
operation of the organization. A person who serves as president, chief 
executive officer, or chief operating officer has this ultimate 
responsibility unless the person demonstrates otherwise. If this 
ultimate responsibility resides with two or more individuals (e.g., co-
presidents), who may exercise such responsibility in concert or 
individually, then each individual is in a position to exercise 
substantial influence over the affairs of the organization.
    (3) Treasurers and chief financial officers. This category includes 
any person who, regardless of title, has ultimate responsibility for 
managing the finances of the organization. A person who serves as 
treasurer or chief financial officer has this ultimate responsibility 
unless the person demonstrates otherwise. If this ultimate 
responsibility resides with two or more individuals who may exercise the 
responsibility in concert or individually, then each individual is in a 
position to exercise substantial influence over the affairs of the 
organization.
    (4) Persons with a material financial interest in a provider-
sponsored organization. For purposes of section 4958, if a hospital that 
participates in a provider-sponsored organization (as defined in section 
1855(e) of the Social Security Act, 42 U.S.C. 1395w-25) is an applicable 
tax-exempt organization, then any person with a material financial 
interest (within the meaning of section 501(o)) in the provider-
sponsored organization has substantial influence with respect to the 
hospital.
    (d) Persons deemed not to have substantial influence. A person is 
deemed not to be in a position to exercise substantial influence over 
the affairs of an applicable tax-exempt organization if that person is 
described in one of the following categories:
    (1) Tax-exempt organizations described in section 501(c)(3). This 
category includes any organization described in section 501(c)(3) and 
exempt from tax under section 501(a).
    (2) Certain section 501(c)(4) organizations. Only with respect to an 
applicable tax-exempt organization described in section 501(c)(4) and 
Sec. 53.4958-2(a)(4), this category includes any other organization so 
described.
    (3) Employees receiving economic benefits of less than a specified 
amount in a taxable year. This category includes, for the taxable year 
in which benefits are provided, any full- or part-time employee of the 
applicable tax-exempt organization who--
    (i) Receives economic benefits, directly or indirectly from the 
organization, of less than the amount referenced for a highly 
compensated employee in section 414(q)(1)(B)(i);
    (ii) Is not described in paragraph (b) or (c) of this section with 
respect to the organization; and
    (iii) Is not a substantial contributor to the organization within 
the meaning of section 507(d)(2)(A), taking into account only 
contributions received by the organization during its current taxable 
year and the four preceding taxable years.
    (e) Facts and circumstances govern in all other cases--(1) In 
general. Whether a person who is not described in paragraph (b), (c) or 
(d) of this section is a disqualified person depends upon all relevant 
facts and circumstances.
    (2) Facts and circumstances tending to show substantial influence. 
Facts and circumstances tending to show that a person has substantial 
influence over the affairs of an organization include, but are not 
limited to, the following--
    (i) The person founded the organization;
    (ii) The person is a substantial contributor to the organization 
(within the meaning of section 507(d)(2)(A)), taking into account only 
contributions received by the organization during its

[[Page 229]]

current taxable year and the four preceding taxable years;
    (iii) The person's compensation is primarily based on revenues 
derived from activities of the organization, or of a particular 
department or function of the organization, that the person controls;
    (iv) The person has or shares authority to control or determine a 
substantial portion of the organization's capital expenditures, 
operating budget, or compensation for employees;
    (v) The person manages a discrete segment or activity of the 
organization that represents a substantial portion of the activities, 
assets, income, or expenses of the organization, as compared to the 
organization as a whole;
    (vi) The person owns a controlling interest (measured by either vote 
or value) in a corporation, partnership, or trust that is a disqualified 
person; or
    (vii) The person is a non-stock organization controlled, directly or 
indirectly, by one or more disqualified persons.
    (3) Facts and circumstances tending to show no substantial 
influence. Facts and circumstances tending to show that a person does 
not have substantial influence over the affairs of an organization 
include, but are not limited to, the following--
    (i) The person has taken a bona fide vow of poverty as an employee, 
agent, or on behalf, of a religious organization;
    (ii) The person is a contractor (such as an attorney, accountant, or 
investment manager or advisor) whose sole relationship to the 
organization is providing professional advice (without having decision-
making authority) with respect to transactions from which the contractor 
will not economically benefit either directly or indirectly (aside from 
customary fees received for the professional advice rendered);
    (iii) The direct supervisor of the individual is not a disqualified 
person;
    (iv) The person does not participate in any management decisions 
affecting the organization as a whole or a discrete segment or activity 
of the organization that represents a substantial portion of the 
activities, assets, income, or expenses of the organization, as compared 
to the organization as a whole; or
    (v) Any preferential treatment a person receives based on the size 
of that person's contribution is also offered to all other donors making 
a comparable contribution as part of a solicitation intended to attract 
a substantial number of contributions.
    (f) Affiliated organizations. In the case of multiple organizations 
affiliated by common control or governing documents, the determination 
of whether a person does or does not have substantial influence shall be 
made separately for each applicable tax-exempt organization. A person 
may be a disqualified person with respect to transactions with more than 
one applicable tax-exempt organization.
    (g) Examples. The following examples illustrate the principles of 
this section. A finding that a person is a disqualified person in the 
following examples does not indicate that an excess benefit transaction 
has occurred. If a person is a disqualified person, the rules of section 
4958(c) and Sec. 53.4958-4 apply to determine whether an excess benefit 
transaction has occurred. The examples are as follows:

    Example 1. N, an artist by profession, works part-time at R, a local 
museum. In the first taxable year in which R employs N, R pays N a 
salary and provides no additional benefits to N except for free 
admission to the museum, a benefit R provides to all of its employees 
and volunteers. The total economic benefits N receives from R during the 
taxable year are less than the amount referenced for a highly 
compensated employee in section 414(q)(1)(B)(i). The part-time job 
constitutes N's only relationship with R. N is not related to any other 
disqualified person with respect to R. N is deemed not to be in a 
position to exercise substantial influence over the affairs of R. 
Therefore, N is not a disqualified person with respect to R in that 
year.
    Example 2. The facts are the same as in Example 1, except that in 
addition to the salary that R pays N for N's services during the taxable 
year, R also purchases one of N's paintings for $x. The total of N's 
salary plus $x exceeds the amount referenced for highly compensated 
employees in section 414(q)(1)(B)(i). Consequently, whether N is in a 
position to exercise substantial influence over the affairs of R for 
that taxable year depends upon all of the relevant facts and 
circumstances.
    Example 3. Q is a member of K, a section 501(c)(3) organization with 
a broad-based

[[Page 230]]

public membership. Members of K are entitled to vote only with respect 
to the annual election of directors and the approval of major 
organizational transactions such as a merger or dissolution. Q is not 
related to any other disqualified person of K. Q has no other 
relationship to K besides being a member of K and occasionally making 
modest donations to K. Whether Q is a disqualified person is determined 
by all relevant facts and circumstances. Q's voting rights, which are 
the same as granted to all members of K, do not place Q in a position to 
exercise substantial influence over K. Under these facts and 
circumstances, Q is not a disqualified person with respect to K.
    Example 4. E is the headmaster of Z, a school that is an applicable 
tax-exempt organization for purposes of section 4958. E reports to Z's 
board of trustees and has ultimate responsibility for supervising Z's 
day-to-day operations. For example, E can hire faculty members and 
staff, make changes to the school's curriculum and discipline students 
without specific board approval. Because E has ultimate responsibility 
for supervising the operation of Z, E is in a position to exercise 
substantial influence over the affairs of Z. Therefore, E is a 
disqualified person with respect to Z.
    Example 5. Y is an applicable tax-exempt organization for purposes 
of section 4958 that decides to use bingo games as a method of 
generating revenue. Y enters into a contract with B, a company that 
operates bingo games. Under the contract, B manages the promotion and 
operation of the bingo activity, provides all necessary staff, 
equipment, and services, and pays Y q percent of the revenue from this 
activity. B retains the balance of the proceeds. Y provides no goods or 
services in connection with the bingo operation other than the use of 
its hall for the bingo games. The annual gross revenue earned from the 
bingo games represents more than half of Y's total annual revenue. B's 
compensation is primarily based on revenues from an activity B controls. 
B also manages a discrete activity of Y that represents a substantial 
portion of Y's income compared to the organization as a whole. Under 
these facts and circumstances, B is in a position to exercise 
substantial influence over the affairs of Y. Therefore, B is a 
disqualified person with respect to Y.
    Example 6. The facts are the same as in Example 5, with the 
additional fact that P owns a majority of the stock of B and is actively 
involved in managing B. Because P owns a controlling interest (measured 
by either vote or value) in and actively manages B, P is also in a 
position to exercise substantial influence over the affairs of Y. 
Therefore, under these facts and circumstances, P is a disqualified 
person with respect to Y.
    Example 7. A, an applicable tax-exempt organization for purposes of 
section 4958, owns and operates one acute care hospital. B, a for-profit 
corporation, owns and operates a number of hospitals. A and B form C, a 
limited liability company. In exchange for proportional ownership 
interests, A contributes its hospital, and B contributes other assets, 
to C. All of A's assets then consist of its membership interest in C. A 
continues to be operated for exempt purposes based almost exclusively on 
the activities it conducts through C. C enters into a management 
agreement with a management company, M, to provide day to day management 
services to C. Subject to supervision by C's board, M is given broad 
discretion to manage C's day to day operation and has ultimate 
responsibility for supervising the management of the hospital. Because M 
has ultimate responsibility for supervising the management of the 
hospital operated by C, A's ownership interest in C is its primary 
asset, and C's activities form the basis for A's continued exemption as 
an organization described in section 501(c)(3), M is in a position to 
exercise substantial influence over the affairs of A. Therefore, M is a 
disqualified person with respect to A.
    Example 8. T is a large university and an applicable tax-exempt 
organization for purposes of section 4958. L is the dean of the College 
of Law of T, a substantial source of revenue for T, including 
contributions from alumni and foundations. L is not related to any other 
disqualified person of T. L does not serve on T's governing body or have 
ultimate responsibility for managing the university as whole. However, 
as dean of the College of Law, L plays a key role in faculty hiring and 
determines a substantial portion of the capital expenditures and 
operating budget of the College of Law. L's compensation is greater than 
the amount referenced for a highly compensated employee in section 
414(q)(1)(B)(i) in the year benefits are provided. L's management of a 
discrete segment of T that represents a substantial portion of the 
income of T (as compared to T as a whole) places L in a position to 
exercise substantial influence over the affairs of T. Under these facts 
and circumstances L is a disqualified person with respect to T.
    Example 9. S chairs a small academic department in the College of 
Arts and Sciences of the same university T described in Example 8. S is 
not related to any other disqualified person of T. S does not serve on 
T's governing body or as an officer of T. As department chair, S 
supervises faculty in the department, approves the course curriculum, 
and oversees the operating budget for the department. S's compensation 
is greater than the amount referenced for a highly compensated employee 
in section 414(q)(1)(B)(i) in the year benefits are provided. Even 
though S manages the department, that department does not represent a 
substantial

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portion of T's activities, assets, income, expenses, or operating 
budget. Therefore, S does not participate in any management decisions 
affecting either T as a whole, or a discrete segment or activity of T 
that represents a substantial portion of its activities, assets, income, 
or expenses. Under these facts and circumstances, S does not have 
substantial influence over the affairs of T, and therefore S is not a 
disqualified person with respect to T.
    Example 10. U is a large acute-care hospital that is an applicable 
tax-exempt organization for purposes of section 4958. U employs X as a 
radiologist. X gives instructions to staff with respect to the radiology 
work X conducts, but X does not supervise other U employees or manage 
any substantial part of U's operations. X's compensation is primarily in 
the form of a fixed salary. In addition, X is eligible to receive an 
incentive award based on revenues of the radiology department. X's 
compensation is greater than the amount referenced for a highly 
compensated employee in section 414(q)(1)(B)(i) in the year benefits are 
provided. X is not related to any other disqualified person of U. X does 
not serve on U's governing body or as an officer of U. Although U 
participates in a provider-sponsored organization (as defined in section 
1855(e) of the Social Security Act), X does not have a material 
financial interest in that organization. X does not receive compensation 
primarily based on revenues derived from activities of U that X 
controls. X does not participate in any management decisions affecting 
either U as a whole or a discrete segment of U that represents a 
substantial portion of its activities, assets, income, or expenses. 
Under these facts and circumstances, X does not have substantial 
influence over the affairs of U, and therefore X is not a disqualified 
person with respect to U.
    Example 11. W is a cardiologist and head of the cardiology 
department of the same hospital U described in Example 10. The 
cardiology department is a major source of patients admitted to U and 
consequently represents a substantial portion of U's income, as compared 
to U as a whole. W does not serve on U's governing board or as an 
officer of U. W does not have a material financial interest in the 
provider-sponsored organization (as defined in section 1855(e) of the 
Social Security Act) in which U participates. W receives a salary and 
retirement and welfare benefits fixed by a three-year renewable 
employment contract with U. W's compensation is greater than the amount 
referenced for a highly compensated employee in section 414(q)(1)(B)(i) 
in the year benefits are provided. As department head, W manages the 
cardiology department and has authority to allocate the budget for that 
department, which includes authority to distribute incentive bonuses 
among cardiologists according to criteria that W has authority to set. 
W's management of a discrete segment of U that represents a substantial 
portion of its income and activities (as compared to U as a whole) 
places W in a position to exercise substantial influence over the 
affairs of U. Under these facts and circumstances, W is a disqualified 
person with respect to U.
    Example 12. M is a museum that is an applicable tax-exempt 
organization for purposes of section 4958. D provides accounting 
services and tax advice to M as a contractor in return for a fee. D has 
no other relationship with M and is not related to any disqualified 
person of M. D does not provide professional advice with respect to any 
transaction from which D might economically benefit either directly or 
indirectly (aside from fees received for the professional advice 
rendered). Because D's sole relationship to M is providing professional 
advice (without having decision-making authority) with respect to 
transactions from which D will not economically benefit either directly 
or indirectly (aside from customary fees received for the professional 
advice rendered), under these facts and circumstances, D is not a 
disqualified person with respect to M.
    Example 13. F is a repertory theater company that is an applicable 
tax-exempt organization for purposes of section 4958. F holds a fund-
raising campaign to pay for the construction of a new theater. J is a 
regular subscriber to F's productions who has made modest gifts to F in 
the past. J has no relationship to F other than as a subscriber and 
contributor. F solicits contributions as part of a broad public campaign 
intended to attract a large number of donors, including a substantial 
number of donors making large gifts. In its solicitations for 
contributions, F promises to invite all contributors giving $z or more 
to a special opening production and party held at the new theater. These 
contributors are also given a special number to call in F's office to 
reserve tickets for performances, make ticket exchanges, and make other 
special arrangements for their convenience. J makes a contribution of $z 
to F, which makes J a substantial contributor within the meaning of 
section 507(d)(2)(A), taking into account only contributions received by 
F during its current and the four preceding taxable years. J receives 
the benefits described in F's solicitation. Because F offers the same 
benefit to all donors of $z or more, the preferential treatment that J 
receives does not indicate that J is in a position to exercise 
substantial influence over the affairs of the organization. Therefore, 
under these facts and circumstances, J is not a disqualified person with 
respect to F.

[T.D. 8978, 67 FR 3083, Jan. 23, 2002]

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Sec. 53.4958-4  Excess benefit transaction.

    (a) Definition of excess benefit transaction--(1) In general. An 
excess benefit transaction means any transaction in which an economic 
benefit is provided by an applicable tax-exempt organization directly or 
indirectly to or for the use of any disqualified person, and the value 
of the economic benefit provided exceeds the value of the consideration 
(including the performance of services) received for providing the 
benefit. Subject to the limitations of paragraph (c) of this section 
(relating to the treatment of economic benefits as compensation for the 
performance of services), to determine whether an excess benefit 
transaction has occurred, all consideration and benefits (except 
disregarded benefits described in paragraph (a)(4) of this section) 
exchanged between a disqualified person and the applicable tax-exempt 
organization and all entities the organization controls (within the 
meaning of paragraph (a)(2)(ii)(B) of this section) are taken into 
account. For example, in determining the reasonableness of compensation 
that is paid (or vests, or is no longer subject to a substantial risk of 
forfeiture) in one year, services performed in prior years may be taken 
into account. The rules of this section apply to all transactions with 
disqualified persons, regardless of whether the amount of the benefit 
provided is determined, in whole or in part, by the revenues of one or 
more activities of the organization. For rules regarding valuation 
standards, see paragraph (b) of this section. For the requirement that 
an applicable tax-exempt organization clearly indicate its intent to 
treat a benefit as compensation for services when paid, see paragraph 
(c) of this section.
    (2) Economic benefit provided indirectly--(i) In general. A 
transaction that would be an excess benefit transaction if the 
applicable tax-exempt organization engaged in it directly with a 
disqualified person is likewise an excess benefit transaction when it is 
accomplished indirectly. An applicable tax-exempt organization may 
provide an excess benefit indirectly to a disqualified person through a 
controlled entity or through an intermediary, as described in paragraphs 
(a)(2)(ii) and (iii) of this section, respectively.
    (ii) Through a controlled entity--(A) In general. An applicable tax-
exempt organization may provide an excess benefit indirectly through the 
use of one or more entities it controls. For purposes of section 4958, 
economic benefits provided by a controlled entity will be treated as 
provided by the applicable tax-exempt organization.
    (B) Definition of control--(1) In general. For purposes of this 
paragraph, control by an applicable tax-exempt organization means--
    (i) In the case of a stock corporation, ownership (by vote or value) 
of more than 50 percent of the stock in such corporation;
    (ii) In the case of a partnership, ownership of more than 50 percent 
of the profits interests or capital interests in the partnership;
    (iii) In the case of a nonstock organization (i.e., an entity in 
which no person holds a proprietary interest), that at least 50 percent 
of the directors or trustees of the organization are either 
representatives (including trustees, directors, agents, or employees) 
of, or directly or indirectly controlled by, an applicable tax-exempt 
organization; or
    (iv) In the case of any other entity, ownership of more than 50 
percent of the beneficial interest in the entity.
    (2) Constructive ownership. Section 318 (relating to constructive 
ownership of stock) shall apply for purposes of determining ownership of 
stock in a corporation. Similar principles shall apply for purposes of 
determining ownership of interests in any other entity.
    (iii) Through an intermediary. An applicable tax-exempt organization 
may provide an excess benefit indirectly through an intermediary. An 
intermediary is any person (including an individual or a taxable or tax-
exempt entity) who participates in a transaction with one or more 
disqualified persons of an applicable tax-exempt organization. For 
purposes of section 4958, economic benefits provided by an intermediary 
will be treated as provided by the applicable tax-exempt organization 
when--
    (A) An applicable tax-exempt organization provides an economic 
benefit to an intermediary; and

[[Page 233]]

    (B) In connection with the receipt of the benefit by the 
intermediary--
    (1) There is evidence of an oral or written agreement or 
understanding that the intermediary will provide economic benefits to or 
for the use of a disqualified person; or
    (2) The intermediary provides economic benefits to or for the use of 
a disqualified person without a significant business purpose or exempt 
purpose of its own.
    (iv) Examples. The following examples illustrate when economic 
benefits are provided indirectly under the rules of this paragraph 
(a)(2):

    Example 1. K is an applicable tax-exempt organization for purposes 
of section 4958. L is a wholly-owned taxable subsidiary of K. J is 
employed by K, and is a disqualified person with respect to K. K pays J 
an annual salary of $12m, and reports that amount as compensation during 
calendar year 2001. Although J only performed services for K for nine 
months of 2001, J performed equivalent services for L during the 
remaining three months of 2001. Taking into account all of the economic 
benefits K provided to J, and all of the services J performed for K and 
L, $12m does not exceed the fair market value of the services J 
performed for K and L during 2001. Therefore, under these facts, K does 
not provide an excess benefit to J directly or indirectly.
    Example 2. F is an applicable tax-exempt organization for purposes 
of section 4958. D is an entity controlled by F within the meaning of 
paragraph (a)(2)(ii)(B) of this section. T is the chief executive 
officer (CEO) of F. As CEO, T is responsible for overseeing the 
activities of F. T's duties as CEO make him a disqualified person with 
respect to F. T's compensation package with F represents the maximum 
reasonable compensation for T's services as CEO. Thus, any additional 
economic benefits that F provides to T without T providing additional 
consideration constitute an excess benefit. D contracts with T to 
provide enumerated consulting services to D. However, the contract does 
not require T to perform any additional services for D that T is not 
already obligated to perform as F's chief executive officer. Therefore, 
any payment to T pursuant to the consulting contract with D represents 
an indirect excess benefit that F provides through a controlled entity, 
even if F, D, or T treats the additional payment to T as compensation.
    Example 3. P is an applicable tax-exempt organization for purposes 
of section 4958. S is a taxable entity controlled by P within the 
meaning of paragraph (a)(2)(ii)(B) of this section. V is the chief 
executive officer of S, for which S pays V $w in salary and benefits. V 
also serves as a voting member of P's governing body. Consequently, V is 
a disqualified person with respect to P. P provides V with $x 
representing compensation for the services V provides P as a member of 
its governing body. Although $x represents reasonable compensation for 
the services V provides directly to P as a member of its governing body, 
the total compensation of $w + $x exceeds reasonable compensation for 
the services V provides to P and S collectively. Therefore, the portion 
of total compensation that exceeds reasonable compensation is an excess 
benefit provided to V.
    Example 4. G is an applicable tax-exempt organization for section 
4958 purposes. F is a disqualified person who was last employed by G in 
a position of substantial influence three years ago. H is an entity 
engaged in scientific research and is unrelated to either F or G. G 
makes a grant to H to fund a research position. H subsequently 
advertises for qualified candidates for the research position. F is 
among several highly qualified candidates who apply for the research 
position. H hires F. There was no evidence of an oral or written 
agreement or understanding with G that H will use G's grant to provide 
economic benefits to or for the use of F. Although G provided economic 
benefits to H, and in connection with the receipt of such benefits, H 
will provide economic benefits to or for the use of F, H acted with a 
significant business purpose or exempt purpose of its own. Under these 
facts, G did not provide an economic benefit to F indirectly through the 
use of an intermediary.

    (3) Exception for fixed payments made pursuant to an initial 
contract--(i) In general. Except as provided in paragraph (a)(3)(iv) of 
this section, section 4958 does not apply to any fixed payment made to a 
person pursuant to an initial contract.
    (ii) Fixed payment--(A) In general. For purposes of paragraph 
(a)(3)(i) of this section, fixed payment means an amount of cash or 
other property specified in the contract, or determined by a fixed 
formula specified in the contract, which is to be paid or transferred in 
exchange for the provision of specified services or property. A fixed 
formula may incorporate an amount that depends upon future specified 
events or contingencies, provided that no person exercises discretion 
when calculating the amount of a payment or deciding whether to make a 
payment (such as a bonus). A specified event or contingency may include 
the amount of revenues generated by (or other objective measure of) one 
or more activities of

[[Page 234]]

the applicable tax-exempt organization. A fixed payment does not include 
any amount paid to a person under a reimbursement (or similar) 
arrangement where discretion is exercised by any person with respect to 
the amount of expenses incurred or reimbursed.
    (B) Special rules. Amounts payable pursuant to a qualified pension, 
profit-sharing, or stock bonus plan under section 401(a), or pursuant to 
an employee benefit program that is subject to and satisfies coverage 
and nondiscrimination rules under the Internal Revenue Code (e.g., 
sections 127 and 137), other than nondiscrimination rules under section 
9802, are treated as fixed payments for purposes of this section, 
regardless of the applicable tax-exempt organization's discretion with 
respect to the plan or program. The fact that a person contracting with 
an applicable tax-exempt organization is expressly granted the choice 
whether to accept or reject any economic benefit is disregarded in 
determining whether the benefit constitutes a fixed payment for purposes 
of this paragraph.
    (iii) Initial contract. For purposes of paragraph (a)(3)(i) of this 
section, initial contract means a binding written contract between an 
applicable tax-exempt organization and a person who was not a 
disqualified person within the meaning of section 4958(f)(1) and Sec. 
53.4958-3 immediately prior to entering into the contract.
    (iv) Substantial performance required. Paragraph (a)(3)(i) of this 
section does not apply to any fixed payment made pursuant to the initial 
contract during any taxable year of the person contracting with the 
applicable tax-exempt organization if the person fails to perform 
substantially the person's obligations under the initial contract during 
that year.
    (v) Treatment as a new contract. A written binding contract that 
provides that the contract is terminable or subject to cancellation by 
the applicable tax-exempt organization (other than as a result of a lack 
of substantial performance by the disqualified person, as described in 
paragraph (a)(3)(iv) of this section) without the other party's consent 
and without substantial penalty to the organization is treated as a new 
contract as of the earliest date that any such termination or 
cancellation, if made, would be effective. Additionally, if the parties 
make a material change to a contract, it is treated as a new contract as 
of the date the material change is effective. A material change includes 
an extension or renewal of the contract (other than an extension or 
renewal that results from the person contracting with the applicable 
tax-exempt organization unilaterally exercising an option expressly 
granted by the contract), or a more than incidental change to any amount 
payable under the contract. The new contract is tested under paragraph 
(a)(3)(iii) of this section to determine whether it is an initial 
contract for purposes of this section.
    (vi) Evaluation of non-fixed payments. Any payment that is not a 
fixed payment (within the meaning of paragraph (a)(3)(ii) of this 
section) is evaluated to determine whether it constitutes an excess 
benefit transaction under section 4958. In making this determination, 
all payments and consideration exchanged between the parties are taken 
into account, including any fixed payments made pursuant to an initial 
contract with respect to which section 4958 does not apply.
    (vii) Examples. The following examples illustrate the rules 
governing fixed payments made pursuant to an initial contract. Unless 
otherwise stated, assume that the person contracting with the applicable 
tax-exempt organization has performed substantially the person's 
obligations under the contract with respect to the payment. The examples 
are as follows:

    Example 1. T is an applicable tax-exempt organization for purposes 
of section 4958. On January 1, 2002, T hires S as its chief financial 
officer by entering into a five-year written employment contract with S. 
S was not a disqualified person within the meaning of section 4958(f)(1) 
and Sec. 53.4958-3 immediately prior to entering into the January 1, 
2002, contract (initial contract). S's duties and responsibilities under 
the contract make S a disqualified person with respect to T (see Sec. 
53.4958-3(c)(3)). Under the initial contract, T agrees to pay S an 
annual salary of $200,000, payable in monthly installments. The contract 
provides that, beginning in 2003, S's annual salary will be adjusted by 
the increase in the Consumer Price Index (CPI) for the prior year. 
Section 4958 does not apply because S's compensation under the contract 
is

[[Page 235]]

a fixed payment pursuant to an initial contract within the meaning of 
paragraph (a)(3) of this section. Thus, for section 4958 purposes, it is 
unnecessary to evaluate whether any portion of the compensation paid to 
S pursuant to the initial contract is an excess benefit transaction.
    Example 2. The facts are the same as in Example 1, except that the 
initial contract provides that, in addition to a base salary of 
$200,000, T may pay S an annual performance-based bonus. The contract 
provides that T's governing body will determine the amount of the annual 
bonus as of the end of each year during the term of the contract, based 
on the board's evaluation of S's performance, but the bonus cannot 
exceed $100,000 per year. Unlike the base salary portion of S's 
compensation, the bonus portion of S's compensation is not a fixed 
payment pursuant to an initial contract, because the governing body has 
discretion over the amount, if any, of the bonus payment. Section 4958 
does not apply to payment of the $200,000 base salary (as adjusted for 
inflation), because it is a fixed payment pursuant to an initial 
contract within the meaning of paragraph (a)(3) of this section. By 
contrast, the annual bonuses that may be paid to S under the initial 
contract are not protected by the initial contract exception. Therefore, 
each bonus payment will be evaluated under section 4958, taking into 
account all payments and consideration exchanged between the parties.
    Example 3. The facts are the same as in Example 1, except that in 
2003, T changes its payroll system, such that T makes biweekly, rather 
than monthly, salary payments to its employees. Beginning in 2003, T 
also grants its employees an additional two days of paid vacation each 
year. Neither change is a material change to S's initial contract within 
the meaning of paragraph (a)(3)(v) of this section. Therefore, section 
4958 does not apply to the base salary payments to S due to the initial 
contract exception.
    Example 4. The facts are the same as in Example 1, except that on 
January 1, 2003, S becomes the chief executive officer of T and a new 
chief financial officer is hired. At the same time, T's board of 
directors approves an increase in S's annual base salary from $200,000 
to $240,000, effective on that day. These changes in S's employment 
relationship constitute material changes of the initial contract within 
the meaning of paragraph (a)(3)(v) of this section. As a result, S is 
treated as entering into a new contract with T on January 1, 2003, at 
which time S is a disqualified person within the meaning of section 
4958(f)(1) and Sec. 53.4958-3. T's payments to S made pursuant to the 
new contract will be evaluated under section 4958, taking into account 
all payments and consideration exchanged between the parties.
    Example 5. J is a performing arts organization and an applicable 
tax-exempt organization for purposes of section 4958. J hires W to 
become the chief executive officer of J. W was not a disqualified person 
within the meaning of section 4958(f)(1) and Sec. 53.4958-3 immediately 
prior to entering into the employment contract with J. As a result of 
this employment contract, W's duties and responsibilities make W a 
disqualified person with respect to J (see Sec. 53.4958-3(c)(2)). Under 
the contract, J will pay W $x (a specified amount) plus a bonus equal to 
2 percent of the total season subscription sales that exceed $100z. The 
$x base salary is a fixed payment pursuant to an initial contract within 
the meaning of paragraph (a)(3) of this section. The bonus payment is 
also a fixed payment pursuant to an initial contract within the meaning 
of paragraph (a)(3) of this section, because no person exercises 
discretion when calculating the amount of the bonus payment or deciding 
whether the bonus will be paid. Therefore, section 4958 does not apply 
to any of J's payments to W pursuant to the employment contract due to 
the initial contract exception.
    Example 6. Hospital B is an applicable tax-exempt organization for 
purposes of section 4958. Hospital B hires E as its chief operating 
officer. E was not a disqualified person within the meaning of section 
4958(f)(1) and Sec. 53.4958-3 immediately prior to entering into the 
employment contract with Hospital B. As a result of this employment 
contract, E's duties and responsibilities make E a disqualified person 
with respect to Hospital B (see Sec. 53.4958-3(c)(2)). E's initial 
employment contract provides that E will have authority to enter into 
hospital management arrangements on behalf of Hospital B. In E's 
personal capacity, E owns more than 35 percent of the combined voting 
power of Company X. Consequently, at the time E becomes a disqualified 
person with respect to B, Company X also becomes a disqualified person 
with respect to B (see Sec. 53.4958-3(b)(2)(i)(A)). E, acting on behalf 
of Hospital B as chief operating officer, enters into a contract with 
Company X under which Company X will provide billing and collection 
services to Hospital B. The initial contract exception of paragraph 
(a)(3)(i) of this section does not apply to the billing and collection 
services contract, because at the time that this contractual arrangement 
was entered into, Company X was a disqualified person with respect to 
Hospital B. Although E's employment contract (which is an initial 
contract) authorizes E to enter into hospital management arrangements on 
behalf of Hospital B, the payments made to Company X are not made 
pursuant to E's employment contract, but rather are made by Hospital B 
pursuant to a separate contractual arrangement with Company X.

[[Page 236]]

Therefore, even if payments made to Company X under the billing and 
collection services contract are fixed payments (within the meaning of 
paragraph (a)(3)(ii) of this section), section 4958 nonetheless applies 
to payments made by Hospital B to Company X because the billing and 
collection services contract itself does not constitute an initial 
contract under paragraph (a)(3)(iii) of this section. Accordingly, all 
payments made to Company X under the billing and collection services 
contract will be evaluated under section 4958.
    Example 7. Hospital C, an applicable tax-exempt organization, enters 
into a contract with Company Y, under which Company Y will provide a 
wide range of hospital management services to Hospital C. Upon entering 
into this contractual arrangement, Company Y becomes a disqualified 
person with respect to Hospital C. The contract provides that Hospital C 
will pay Company Y a management fee of x percent of adjusted gross 
revenue (i.e., gross revenue increased by the cost of charity care 
provided to indigents) annually for a five-year period. The management 
services contract specifies the cost accounting system and the standards 
for indigents to be used in calculating the cost of charity care. The 
cost accounting system objectively defines the direct and indirect costs 
of all health care goods and services provided as charity care. Because 
Company Y was not a disqualified person with respect to Hospital C 
immediately before entering into the management services contract, that 
contract is an initial contract within the meaning of paragraph 
(a)(3)(iii) of this section. The annual management fee paid to Company Y 
is determined by a fixed formula specified in the contract, and is 
therefore a fixed payment within the meaning of paragraph (a)(3)(ii) of 
this section. Accordingly, section 4958 does not apply to the annual 
management fee due to the initial contract exception.
    Example 8. The facts are the same as in Example 7, except that the 
management services contract also provides that Hospital C will 
reimburse Company Y on a monthly basis for certain expenses incurred by 
Company Y that are attributable to management services provided to 
Hospital C (e.g., legal fees and travel expenses). Although the 
management fee itself is a fixed payment not subject to section 4958, 
the reimbursement payments that Hospital C makes to Company Y for the 
various expenses covered by the contract are not fixed payments within 
the meaning of paragraph (a)(3)(ii) of this section, because Company Y 
exercises discretion with respect to the amount of expenses incurred. 
Therefore, any reimbursement payments that Hospital C pays pursuant to 
the contract will be evaluated under section 4958.
    Example 9. X, an applicable tax-exempt organization for purposes of 
section 4958, hires C to conduct scientific research. On January 1, 
2003, C enters into a three-year written employment contract with X 
(initial contract). Under the terms of the contract, C is required to 
work full-time at X's laboratory for a fixed annual salary of $90,000. 
Immediately prior to entering into the employment contract, C was not a 
disqualified person within the meaning of section 4958(f)(1) and Sec. 
53.4958-3, nor did C become a disqualified person pursuant to the 
initial contract. However, two years after joining X, C marries D, who 
is the child of X's president. As D's spouse, C is a disqualified person 
within the meaning of section 4958(f)(1) and Sec. 53.4958-3 with 
respect to X. Nonetheless, section 4958 does not apply to X's salary 
payments to C due to the initial contract exception.
    Example 10. The facts are the same as in Example 9, except that the 
initial contract included a below-market loan provision under which C 
has the unilateral right to borrow up to a specified dollar amount from 
X at a specified interest rate for a specified term. After C's marriage 
to D, C borrows money from X to purchase a home under the terms of the 
initial contract. Section 4958 does not apply to X's loan to C due to 
the initial contract exception.
    Example 11. The facts are the same as in Example 9, except that 
after C's marriage to D, C works only sporadically at the laboratory, 
and performs no other services for X. Notwithstanding that C fails to 
perform substantially C's obligations under the initial contract, X does 
not exercise its right to terminate the initial contract for 
nonperformance and continues to pay full salary to C. Pursuant to 
paragraph (a)(3)(iv) of this section, the initial contract exception 
does not apply to any payments made pursuant to the initial contract 
during any taxable year of C in which C fails to perform substantially 
C's obligations under the initial contract.

    (4) Certain economic benefits disregarded for purposes of section 
4958. The following economic benefits are disregarded for purposes of 
section 4958--
    (i) Nontaxable fringe benefits. An economic benefit that is excluded 
from income under section 132, except any liability insurance premium, 
payment, or reimbursement that must be taken into account under 
paragraph (b)(1)(ii)(B)(2) of this section;
    (ii) Expense reimbursement payments pursuant to accountable plans. 
Amounts paid under reimbursement arrangements that meet the requirements 
of Sec. 1.62-2(c) of this chapter;
    (iii) Certain economic benefits provided to a volunteer for the 
organization. An economic benefit provided to a volunteer for the 
organization if the benefit

[[Page 237]]

is provided to the general public in exchange for a membership fee or 
contribution of $75 or less per year;
    (iv) Certain economic benefits provided to a member of, or donor to, 
the organization. An economic benefit provided to a member of an 
organization solely on account of the payment of a membership fee, or to 
a donor solely on account of a contribution for which a deduction is 
allowable under section 170 (charitable contribution), regardless of 
whether the donor is eligible to claim the deduction, if--
    (A) Any non-disqualified person paying a membership fee or making a 
charitable contribution above a specified amount to the organization is 
given the option of receiving substantially the same economic benefit; 
and
    (B) The disqualified person and a significant number of non-
disqualified persons make a payment or charitable contribution of at 
least the specified amount;
    (v) Economic benefits provided to a charitable beneficiary. An 
economic benefit provided to a person solely because the person is a 
member of a charitable class that the applicable tax-exempt organization 
intends to benefit as part of the accomplishment of the organization's 
exempt purpose; and
    (vi) Certain economic benefits provided to a governmental unit. Any 
transfer of an economic benefit to or for the use of a governmental unit 
defined in section 170(c)(1), if the transfer is for exclusively public 
purposes.
    (5) Exception for certain payments made pursuant to an exemption 
granted by the Department of Labor under ERISA. Section 4958 does not 
apply to any payment made pursuant to, and in accordance with, a final 
individual prohibited transaction exemption issued by the Department of 
Labor under section 408(a) of the Employee Retirement Income Security 
Act of 1974 (88 Stat. 854) (ERISA) with respect to a transaction 
involving a plan (as defined in section 3(3) of ERISA) that is an 
applicable tax exempt organization.
    (b) Valuation standards--(1) In general. This section provides rules 
for determining the value of economic benefits for purposes of section 
4958.
    (i) Fair market value of property. The value of property, including 
the right to use property, for purposes of section 4958 is the fair 
market value (i.e., the price at which property or the right to use 
property would change hands between a willing buyer and a willing 
seller, neither being under any compulsion to buy, sell or transfer 
property or the right to use property, and both having reasonable 
knowledge of relevant facts).
    (ii) Reasonable compensation--(A) In general. The value of services 
is the amount that would ordinarily be paid for like services by like 
enterprises (whether taxable or tax-exempt) under like circumstances 
(i.e., reasonable compensation). Section 162 standards apply in 
determining reasonableness of compensation, taking into account the 
aggregate benefits (other than any benefits specifically disregarded 
under paragraph (a)(4) of this section) provided to a person and the 
rate at which any deferred compensation accrues. The fact that a 
compensation arrangement is subject to a cap is a relevant factor in 
determining the reasonableness of compensation. The fact that a State or 
local legislative or agency body or court has authorized or approved a 
particular compensation package paid to a disqualified person is not 
determinative of the reasonableness of compensation for purposes of 
section 4958.
    (B) Items included in determining the value of compensation for 
purposes of determining reasonableness under section 4958. Except for 
economic benefits that are disregarded for purposes of section 4958 
under paragraph (a)(4) of this section, compensation for purposes of 
determining reasonableness under section 4958 includes all economic 
benefits provided by an applicable tax-exempt organization in exchange 
for the performance of services. These benefits include, but are not 
limited to--
    (1) All forms of cash and noncash compensation, including salary, 
fees, bonuses, severance payments, and deferred and noncash compensation 
described in Sec. 53.4958-1(e)(2);
    (2) Unless excludable from income as a de minimis fringe benefit 
pursuant to section 132(a)(4), the payment of liability insurance 
premiums for, or the payment or reimbursement by the organization of--

[[Page 238]]

    (i) Any penalty, tax, or expense of correction owed under section 
4958;
    (ii) Any expense not reasonably incurred by the person in connection 
with a civil judicial or civil administrative proceeding arising out of 
the person's performance of services on behalf of the applicable tax-
exempt organization; or
    (iii) Any expense resulting from an act or failure to act with 
respect to which the person has acted willfully and without reasonable 
cause; and
    (3) All other compensatory benefits, whether or not included in 
gross income for income tax purposes, including payments to welfare 
benefit plans, such as plans providing medical, dental, life insurance, 
severance pay, and disability benefits, and both taxable and nontaxable 
fringe benefits (other than fringe benefits described in section 132), 
including expense allowances or reimbursements (other than expense 
reimbursements pursuant to an accountable plan that meets the 
requirements of Sec. 1.62-2(c)), and the economic benefit of a below-
market loan (within the meaning of section 7872(e)(1)). (For this 
purpose, the economic benefit of a below-market loan is the amount 
deemed transferred to the disqualified person under section 7872(a) or 
(b), regardless of whether section 7872 otherwise applies to the loan).
    (C) Inclusion in compensation for reasonableness determination does 
not govern income tax treatment. The determination of whether any item 
listed in paragraph (b)(1)(ii)(B) of this section is included in the 
disqualified person's gross income for income tax purposes is made on 
the basis of the provisions of chapter 1 of Subtitle A of the Internal 
Revenue Code, without regard to whether the item is taken into account 
for purposes of determining reasonableness of compensation under section 
4958.
    (2) Timing of reasonableness determination--(i) In general. The 
facts and circumstances to be taken into consideration in determining 
reasonableness of a fixed payment (within the meaning of paragraph 
(a)(3)(ii) of this section) are those existing on the date the parties 
enter into the contract pursuant to which the payment is made. However, 
in the event of substantial non-performance, reasonableness is 
determined based on all facts and circumstances, up to and including 
circumstances as of the date of payment. In the case of any payment that 
is not a fixed payment under a contract, reasonableness is determined 
based on all facts and circumstances, up to and including circumstances 
as of the date of payment. In no event shall circumstances existing at 
the date when the payment is questioned be considered in making a 
determination of the reasonableness of the payment. These general timing 
rules also apply to property subject to a substantial risk of 
forfeiture. Therefore, if the property subject to a substantial risk of 
forfeiture satisfies the definition of fixed payment (within the meaning 
of paragraph (a)(3)(ii) of this section), reasonableness is determined 
at the time the parties enter into the contract providing for the 
transfer of the property. If the property is not a fixed payment, then 
reasonableness is determined based on all facts and circumstances up to 
and including circumstances as of the date of payment.
    (ii) Treatment as a new contract. For purposes of paragraph 
(b)(2)(i) of this section, a written binding contract that provides that 
the contract is terminable or subject to cancellation by the applicable 
tax-exempt organization without the other party's consent and without 
substantial penalty to the organization is treated as a new contract as 
of the earliest date that any such termination or cancellation, if made, 
would be effective. Additionally, if the parties make a material change 
to a contract (within the meaning of paragraph (a)(3)(v) of this 
section), it is treated as a new contract as of the date the material 
change is effective.
    (iii) Examples. The following examples illustrate the timing of the 
reasonableness determination under the rules of this paragraph (b)(2):

    Example 1. G is an applicable tax-exempt organization for purposes 
of section 4958. H is an employee of G and a disqualified person with 
respect to G. H's new multi-year employment contract provides for 
payment of a salary and provision of specific benefits pursuant to a 
qualified pension plan under section 401(a) and an accident and health 
plan that meets the requirements of section

[[Page 239]]

105(h)(2). The contract provides that H's salary will be adjusted by the 
increase in the Consumer Price Index (CPI) for the prior year. The 
contributions G makes to the qualified pension plan are equal to the 
maximum amount G is permitted to contribute under the rules applicable 
to qualified plans. Under these facts, all items comprising H's total 
compensation are treated as fixed payments within the meaning of 
paragraph (a)(3)(ii) of this section. Therefore, the reasonableness of 
H's compensation is determined based on the circumstances existing at 
the time G and H enter into the employment contract.
    Example 2. The facts are the same as in Example 1, except that the 
multi-year employment contract provides, in addition, that G will 
transfer title to a car to H under the condition that if H fails to 
complete x years of service with G, title to the car will be forfeited 
back to G. All relevant information about the type of car to be provided 
(including the make, model, and year) is included in the contract. 
Although ultimate vesting of title to the car is contingent on H 
continuing to work for G for x years, the amount of property to be 
vested (i.e., the type of car) is specified in the contract, and no 
person exercises discretion regarding the type of property or whether H 
will retain title to the property at the time of vesting. Under these 
facts, the car is a fixed payment within the meaning of paragraph 
(a)(3)(ii) of this section. Therefore, the reasonableness of H's 
compensation, including the value of the car, is determined based on the 
circumstances existing at the time G and H enter into the employment 
contract.
    Example 3. N is an applicable tax-exempt organization for purposes 
of section 4958. On January 2, N's governing body enters into a new one-
year employment contract with K, its executive director, who is a 
disqualified person with respect to N. The contract provides that K will 
receive a specified amount of salary, contributions to a qualified 
pension plan under section 401(a), and other benefits pursuant to a 
section 125 cafeteria plan. In addition, the contract provides that N's 
governing body may, in its discretion, declare a bonus to be paid to K 
at any time during the year covered by the contract. K's salary and 
other specified benefits constitute fixed payments within the meaning of 
paragraph (a)(3)(ii) of this section. Therefore, the reasonableness of 
those economic benefits is determined on the date when the contract was 
made. However, because the bonus payment is not a fixed payment within 
the meaning of paragraph (a)(3)(ii) of this section, the determination 
of whether any bonus awarded to N is reasonable must be made based on 
all facts and circumstances (including all payments and consideration 
exchanged between the parties), up to and including circumstances as of 
the date of payment of the bonus.

    (c) Establishing intent to treat economic benefit as consideration 
for the performance of services--(1) In general. An economic benefit is 
not treated as consideration for the performance of services unless the 
organization providing the benefit clearly indicates its intent to treat 
the benefit as compensation when the benefit is paid. Except as provided 
in paragraph (c)(2) of this section, an applicable tax-exempt 
organization (or entity controlled by an applicable tax-exempt 
organization, within the meaning of paragraph (a)(2)(ii)(B) of this 
section) is treated as clearly indicating its intent to provide an 
economic benefit as compensation for services only if the organization 
provides written substantiation that is contemporaneous with the 
transfer of the economic benefit at issue. If an organization fails to 
provide this contemporaneous substantiation, any services provided by 
the disqualified person will not be treated as provided in consideration 
for the economic benefit for purposes of determining the reasonableness 
of the transaction. In no event shall an economic benefit that a 
disqualified person obtains by theft or fraud be treated as 
consideration for the performance of services.
    (2) Nontaxable benefits. For purposes of section 4958(c)(1)(A) and 
this section, an applicable tax-exempt organization is not required to 
indicate its intent to provide an economic benefit as compensation for 
services if the economic benefit is excluded from the disqualified 
person's gross income for income tax purposes on the basis of the 
provisions of chapter 1 of Subtitle A of the Internal Revenue Code. 
Examples of these benefits include, but are not limited to, employer-
provided health benefits and contributions to a qualified pension, 
profit-sharing, or stock bonus plan under section 401(a), and benefits 
described in sections 127 and 137. However, except for economic benefits 
that are disregarded for purposes of section 4958 under paragraph (a)(4) 
of this section, all compensatory benefits (regardless of the Federal 
income tax treatment) provided by an organization in exchange for the 
performance of

[[Page 240]]

services are taken into account in determining the reasonableness of a 
person's compensation for purposes of section 4958.
    (3) Contemporaneous substantiation--(i) Reporting of benefit--(A) In 
general. An applicable tax-exempt organization provides contemporaneous 
written substantiation of its intent to provide an economic benefit as 
compensation if--
    (1) The organization reports the economic benefit as compensation on 
an original Federal tax information return with respect to the payment 
(e.g., Form W-2, ``Wage and Tax Statement'', or Form 1099, 
``Miscellaneous Income'') or with respect to the organization (e.g., 
Form 990, ``Return of Organization Exempt From Income Tax''), or on an 
amended Federal tax information return filed prior to the commencement 
of an Internal Revenue Service examination of the applicable tax-exempt 
organization or the disqualified person for the taxable year in which 
the transaction occurred (as determined under Sec. 53.4958-1(e)); or
    (2) The recipient disqualified person reports the benefit as income 
on the person's original Federal tax return (e.g., Form 1040, ``U.S. 
Individual Income Tax Return''), or on the person's amended Federal tax 
return filed prior to the earlier of the following dates--
    (i) Commencement of an Internal Revenue Service examination 
described in paragraph (c)(3)(i)(A)(1) of this section; or
    (ii) The first documentation in writing by the Internal Revenue 
Service of a potential excess benefit transaction involving either the 
applicable tax-exempt organization or the disqualified person.
    (B) Failure to report due to reasonable cause. If an applicable tax-
exempt organization's failure to report an economic benefit as required 
under the Internal Revenue Code is due to reasonable cause (within the 
meaning of Sec. 301.6724-1 of this chapter), then the organization will 
be treated as having clearly indicated its intent to provide an economic 
benefit as compensation for services. To show that its failure to report 
an economic benefit that should have been reported on an information 
return was due to reasonable cause, an applicable tax-exempt 
organization must establish that there were significant mitigating 
factors with respect to its failure to report (as described in Sec. 
301.6724-1(b) of this chapter), or the failure arose from events beyond 
the organization's control (as described in Sec. 301.6724-1(c) of this 
chapter), and that the organization acted in a responsible manner both 
before and after the failure occurred (as described in Sec. 301.6724-
1(d) of this chapter).
    (ii) Other written contemporaneous evidence. In addition, other 
written contemporaneous evidence may be used to demonstrate that the 
appropriate decision-making body or an officer authorized to approve 
compensation approved a transfer as compensation for services in 
accordance with established procedures, including but not limited to--
    (A) An approved written employment contract executed on or before 
the date of the transfer;
    (B) Documentation satisfying the requirements of Sec. 53.4958-
6(a)(3) indicating that an authorized body approved the transfer as 
compensation for services on or before the date of the transfer; or
    (C) Written evidence that was in existence on or before the due date 
of the applicable Federal tax return described in paragraph 
(c)(3)(i)(A)(1) or (2) of this section (including extensions but not 
amendments), of a reasonable belief by the applicable tax-exempt 
organization that a benefit was a nontaxable benefit as defined in 
paragraph (c)(2) of this section.
    (4) Examples. The following examples illustrate the requirement that 
an organization contemporaneously substantiate its intent to provide an 
economic benefit as compensation for services, as defined in paragraph 
(c) of this section:

    Example 1. G is an applicable tax-exempt organization for purposes 
of section 4958. G hires an individual contractor, P, who is also the 
child of a disqualified person of G, to design a computer program for 
it. G executes a contract with P for that purpose in accordance with G's 
established procedures, and pays P $1,000 during the year pursuant to 
the contract. Before January 31 of the next year, G reports the full 
amount paid to P under the contract on a Form 1099 filed with the 
Internal Revenue Service. G will be treated as providing contemporaneous 
written substantiation of its intent to provide the $1,000

[[Page 241]]

paid to P as compensation for the services P performed under the 
contract by virtue of either the Form 1099 filed with the Internal 
Revenue Service reporting the amount, or by virtue of the written 
contract executed between G and P.
    Example 2. G is an applicable tax-exempt organization for purposes 
of section 4958. D is the chief operating officer of G, and a 
disqualified person with respect to G. D receives a bonus at the end of 
the year. G's accounting department determines that the bonus is to be 
reported on D's Form W-2. Due to events beyond G's control, the bonus is 
not reflected on D's Form W-2. As a result, D fails to report the bonus 
on D's individual income tax return. G acts to amend Forms W-2 affected 
as soon as G is made aware of the error during an Internal Revenue 
Service examination. G's failure to report the bonus on an information 
return issued to D arose from events beyond G's control, and G acted in 
a responsible manner both before and after the failure occurred. Thus, 
because G had reasonable cause (within the meaning Sec. 301.6724-1 of 
this chapter) for failing to report D's bonus, G will be treated as 
providing contemporaneous written substantiation of its intent to 
provide the bonus as compensation for services when paid.
    Example 3. H is an applicable tax-exempt organization and J is a 
disqualified person with respect to H. J's written employment agreement 
provides for a fixed salary of $y. J's duties include soliciting funds 
for various programs of H. H raises a large portion of its funds in a 
major metropolitan area. Accordingly, H maintains an apartment there in 
order to provide a place to entertain potential donors. H makes the 
apartment available exclusively to J to assist in the fundraising. J's 
written employment contract does not mention the use of the apartment. H 
obtains the written opinion of a benefits compensation expert that the 
rental value of the apartment is not includable in J's income by reason 
of section 119, based on the expectation that the apartment will be used 
for fundraising activities. Consequently, H does not report the rental 
value of the apartment on J's Form W-2, which otherwise correctly 
reports J's taxable compensation. J does not report the rental value of 
the apartment on J's individual Form 1040. Later, the Internal Revenue 
Service correctly determines that the requirements of section 119 were 
not satisfied. Because of the written expert opinion, H has written 
evidence of its reasonable belief that use of the apartment was a 
nontaxable benefit as defined in paragraph (c)(2) of this section. That 
evidence was in existence on or before the due date of the applicable 
Federal tax return. Therefore, H has demonstrated its intent to treat 
the use of the apartment as compensation for services performed by J.

[T.D. 8978, 67 FR 3083, Jan. 23, 2002; 67 FR 12472, Mar. 19, 2002]



Sec. 53.4958-5  Transaction in which the amount of the economic benefit
is determined in whole or in part by the revenues of one or more 

activities of the organization. [Reserved]



Sec. 53.4958-6  Rebuttable presumption that a transaction is not an
excess benefit transaction.

    (a) In general. Payments under a compensation arrangement are 
presumed to be reasonable, and a transfer of property, or the right to 
use property, is presumed to be at fair market value, if the following 
conditions are satisfied--
    (1) The compensation arrangement or the terms of the property 
transfer are approved in advance by an authorized body of the applicable 
tax-exempt organization (or an entity controlled by the organization 
within the meaning of Sec. 53.4958-4(a)(2)(ii)(B)) composed entirely of 
individuals who do not have a conflict of interest (within the meaning 
of paragraph (c)(1)(iii) of this section) with respect to the 
compensation arrangement or property transfer, as described in paragraph 
(c)(1) of this section;
    (2) The authorized body obtained and relied upon appropriate data as 
to comparability prior to making its determination, as described in 
paragraph (c)(2) of this section; and
    (3) The authorized body adequately documented the basis for its 
determination concurrently with making that determination, as described 
in paragraph (c)(3) of this section.
    (b) Rebutting the presumption. If the three requirements of 
paragraph (a) of this section are satisfied, then the Internal Revenue 
Service may rebut the presumption that arises under paragraph (a) of 
this section only if it develops sufficient contrary evidence to rebut 
the probative value of the comparability data relied upon by the 
authorized body. With respect to any fixed payment (within the meaning 
of Sec. 53.4958-4(a)(3)(ii)), rebuttal evidence is limited to evidence 
relating to facts and circumstances existing on the date

[[Page 242]]

the parties enter into the contract pursuant to which the payment is 
made (except in the event of substantial nonperformance). With respect 
to all other payments (including non-fixed payments subject to a cap, as 
described in paragraph (d)(2) of this section), rebuttal evidence may 
include facts and circumstances up to and including the date of payment. 
See Sec. 53.4958-4(b)(2)(i).
    (c) Requirements for invoking rebuttable presumption--(1) Approval 
by an authorized body--(i) In general. An authorized body means--
    (A) The governing body (i.e., the board of directors, board of 
trustees, or equivalent controlling body) of the organization;
    (B) A committee of the governing body, which may be composed of any 
individuals permitted under State law to serve on such a committee, to 
the extent that the committee is permitted by State law to act on behalf 
of the governing body; or
    (C) To the extent permitted under State law, other parties 
authorized by the governing body of the organization to act on its 
behalf by following procedures specified by the governing body in 
approving compensation arrangements or property transfers.
    (ii) Individuals not included on authorized body. For purposes of 
determining whether the requirements of paragraph (a) of this section 
have been met with respect to a specific compensation arrangement or 
property transfer, an individual is not included on the authorized body 
when it is reviewing a transaction if that individual meets with other 
members only to answer questions, and otherwise recuses himself or 
herself from the meeting and is not present during debate and voting on 
the compensation arrangement or property transfer.
    (iii) Absence of conflict of interest. A member of the authorized 
body does not have a conflict of interest with respect to a compensation 
arrangement or property transfer only if the member--
    (A) Is not a disqualified person participating in or economically 
benefitting from the compensation arrangement or property transfer, and 
is not a member of the family of any such disqualified person, as 
described in section 4958(f)(4) or Sec. 53.4958-3(b)(1);
    (B) Is not in an employment relationship subject to the direction or 
control of any disqualified person participating in or economically 
benefitting from the compensation arrangement or property transfer;
    (C) Does not receive compensation or other payments subject to 
approval by any disqualified person participating in or economically 
benefitting from the compensation arrangement or property transfer;
    (D) Has no material financial interest affected by the compensation 
arrangement or property transfer; and
    (E) Does not approve a transaction providing economic benefits to 
any disqualified person participating in the compensation arrangement or 
property transfer, who in turn has approved or will approve a 
transaction providing economic benefits to the member.
    (2) Appropriate data as to comparability--(i) In general. An 
authorized body has appropriate data as to comparability if, given the 
knowledge and expertise of its members, it has information sufficient to 
determine whether, under the standards set forth in Sec. 53.4958-4(b), 
the compensation arrangement in its entirety is reasonable or the 
property transfer is at fair market value. In the case of compensation, 
relevant information includes, but is not limited to, compensation 
levels paid by similarly situated organizations, both taxable and tax-
exempt, for functionally comparable positions; the availability of 
similar services in the geographic area of the applicable tax-exempt 
organization; current compensation surveys compiled by independent 
firms; and actual written offers from similar institutions competing for 
the services of the disqualified person. In the case of property, 
relevant information includes, but is not limited to, current 
independent appraisals of the value of all property to be transferred; 
and offers received as part of an open and competitive bidding process.
    (ii) Special rule for compensation paid by small organizations. For 
organizations with annual gross receipts (including contributions) of 
less than $1

[[Page 243]]

million reviewing compensation arrangements, the authorized body will be 
considered to have appropriate data as to comparability if it has data 
on compensation paid by three comparable organizations in the same or 
similar communities for similar services. No inference is intended with 
respect to whether circumstances falling outside this safe harbor will 
meet the requirement with respect to the collection of appropriate data.
    (iii) Application of special rule for small organizations. For 
purposes of determining whether the special rule for small organizations 
described in paragraph (c)(2)(ii) of this section applies, an 
organization may calculate its annual gross receipts based on an average 
of its gross receipts during the three prior taxable years. If any 
applicable tax-exempt organization is controlled by or controls another 
entity (as defined in Sec. 53.4958-4(a)(2)(ii)(B)), the annual gross 
receipts of such organizations must be aggregated to determine 
applicability of the special rule stated in paragraph (c)(2)(ii) of this 
section.
    (iv) Examples. The following examples illustrate the rules for 
appropriate data as to comparability for purposes of invoking the 
rebuttable presumption of reasonableness described in this section. In 
all examples, compensation refers to the aggregate value of all benefits 
provided in exchange for services. The examples are as follows:

    Example 1. Z is a university that is an applicable tax-exempt 
organization for purposes of section 4958. Z is negotiating a new 
contract with Q, its president, because the old contract will expire at 
the end of the year. In setting Q's compensation for its president at 
$600x per annum, the executive committee of the Board of Trustees relies 
solely on a national survey of compensation for university presidents 
that indicates university presidents receive annual compensation in the 
range of $100x to $700x; this survey does not divide its data by any 
criteria, such as the number of students served by the institution, 
annual revenues, academic ranking, or geographic location. Although many 
members of the executive committee have significant business experience, 
none of the members has any particular expertise in higher education 
compensation matters. Given the failure of the survey to provide 
information specific to universities comparable to Z, and because no 
other information was presented, the executive committee's decision with 
respect to Q's compensation was not based upon appropriate data as to 
comparability.
    Example 2. The facts are the same as Example 1, except that the 
national compensation survey divides the data regarding compensation for 
university presidents into categories based on various university-
specific factors, including the size of the institution (in terms of the 
number of students it serves and the amount of its revenues) and 
geographic area. The survey data shows that university presidents at 
institutions comparable to and in the same geographic area as Z receive 
annual compensation in the range of $200x to $300x. The executive 
committee of the Board of Trustees of Z relies on the survey data and 
its evaluation of Q's many years of service as a tenured professor and 
high-ranking university official at Z in setting Q's compensation at 
$275x annually. The data relied upon by the executive committee 
constitutes appropriate data as to comparability.
    Example 3. X is a tax-exempt hospital that is an applicable tax-
exempt organization for purposes of section 4958. Before renewing the 
contracts of X's chief executive officer and chief financial officer, 
X's governing board commissioned a customized compensation survey from 
an independent firm that specializes in consulting on issues related to 
executive placement and compensation. The survey covered executives with 
comparable responsibilities at a significant number of taxable and tax-
exempt hospitals. The survey data are sorted by a number of different 
variables, including the size of the hospitals and the nature of the 
services they provide, the level of experience and specific 
responsibilities of the executives, and the composition of the annual 
compensation packages. The board members were provided with the survey 
results, a detailed written analysis comparing the hospital's executives 
to those covered by the survey, and an opportunity to ask questions of a 
member of the firm that prepared the survey. The survey, as prepared and 
presented to X's board, constitutes appropriate data as to 
comparability.
    Example 4. The facts are the same as Example 3, except that one year 
later, X is negotiating a new contract with its chief executive officer. 
The governing board of X obtains information indicating that the 
relevant market conditions have not changed materially, and possesses no 
other information indicating that the results of the prior year's survey 
are no longer valid. Therefore, X may continue to rely on the 
independent compensation survey prepared for the prior year in setting 
annual compensation under the new contract.
    Example 5. W is a local repertory theater and an applicable tax-
exempt organization for purposes of section 4958. W has had annual gross 
receipts ranging from $400,000 to

[[Page 244]]

$800,000 over its past three taxable years. In determining the next 
year's compensation for W's artistic director, the board of directors of 
W relies on data compiled from a telephone survey of three other 
unrelated performing arts organizations of similar size in similar 
communities. A member of the board drafts a brief written summary of the 
annual compensation information obtained from this informal survey. The 
annual compensation information obtained in the telephone survey is 
appropriate data as to comparability.

    (3) Documentation--(i) For a decision to be documented adequately, 
the written or electronic records of the authorized body must note--
    (A) The terms of the transaction that was approved and the date it 
was approved;
    (B) The members of the authorized body who were present during 
debate on the transaction that was approved and those who voted on it;
    (C) The comparability data obtained and relied upon by the 
authorized body and how the data was obtained; and
    (D) Any actions taken with respect to consideration of the 
transaction by anyone who is otherwise a member of the authorized body 
but who had a conflict of interest with respect to the transaction.
    (ii) If the authorized body determines that reasonable compensation 
for a specific arrangement or fair market value in a specific property 
transfer is higher or lower than the range of comparability data 
obtained, the authorized body must record the basis for its 
determination. For a decision to be documented concurrently, records 
must be prepared before the later of the next meeting of the authorized 
body or 60 days after the final action or actions of the authorized body 
are taken. Records must be reviewed and approved by the authorized body 
as reasonable, accurate and complete within a reasonable time period 
thereafter.
    (d) No presumption with respect to non-fixed payments until amounts 
are determined--(1) In general. Except as provided in paragraph (d)(2) 
of this section, in the case of a payment that is not a fixed payment 
(within the meaning of Sec. 53.4958-4(a)(3)(ii)), the rebuttable 
presumption of this section arises only after the exact amount of the 
payment is determined, or a fixed formula for calculating the payment is 
specified, and the three requirements for the presumption under 
paragraph (a) of this section subsequently are satisfied. See Sec. 
53.4958-4(b)(2)(i).
    (2) Special rule for certain non-fixed payments subject to a cap. If 
the authorized body approves an employment contract with a disqualified 
person that includes a non-fixed payment (such as a discretionary bonus) 
subject to a specified cap, the authorized body may establish a 
rebuttable presumption with respect to the non-fixed payment at the time 
the employment contract is entered into if--
    (i) Prior to approving the contract, the authorized body obtains 
appropriate comparability data indicating that a fixed payment of up to 
a certain amount to the particular disqualified person would represent 
reasonable compensation;
    (ii) The maximum amount payable under the contract (taking into 
account both fixed and non-fixed payments) does not exceed the amount 
referred to in paragraph (d)(2)(i) of this section; and
    (iii) The other requirements for the rebuttable presumption of 
reasonableness under paragraph (a) of this section are satisfied.
    (e) No inference from absence of presumption. The fact that a 
transaction between an applicable tax-exempt organization and a 
disqualified person is not subject to the presumption described in this 
section neither creates any inference that the transaction is an excess 
benefit transaction, nor exempts or relieves any person from compliance 
with any Federal or state law imposing any obligation, duty, 
responsibility, or other standard of conduct with respect to the 
operation or administration of any applicable tax-exempt organization.
    (f) Period of reliance on rebuttable presumption. Except as provided 
in paragraph (d) of this section with respect to non-fixed payments, the 
rebuttable presumption applies to all payments made or transactions 
completed in accordance with a contract, provided that the provisions of 
paragraph (a) of

[[Page 245]]

this section were met at the time the parties entered into the contract.

[T.D. 8978, 67 FR 3083, Jan. 23, 2002]



Sec. 53.4958-7  Correction.

    (a) In general. An excess benefit transaction is corrected by 
undoing the excess benefit to the extent possible, and taking any 
additional measures necessary to place the applicable tax-exempt 
organization involved in the excess benefit transaction in a financial 
position not worse than that in which it would be if the disqualified 
person were dealing under the highest fiduciary standards. Paragraph (b) 
of this section describes the acceptable forms of correction. Paragraph 
(c) of this section defines the correction amount. Paragraph (d) of this 
section describes correction where a contract has been partially 
performed. Paragraph (e) of this section describes correction where the 
applicable tax-exempt organization involved in the transaction has 
ceased to exist or is no longer tax-exempt. Paragraph (f) of this 
section provides examples illustrating correction.
    (b) Form of correction--(1) Cash or cash equivalents. Except as 
provided in paragraphs (b)(3) and (4) of this section, a disqualified 
person corrects an excess benefit only by making a payment in cash or 
cash equivalents, excluding payment by a promissory note, to the 
applicable tax-exempt organization equal to the correction amount, as 
defined in paragraph (c) of this section.
    (2) Anti-abuse rule. A disqualified person will not satisfy the 
requirements of paragraph (b)(1) of this section if the Commissioner 
determines that the disqualified person engaged in one or more 
transactions with the applicable tax-exempt organization to circumvent 
the requirements of this correction section, and as a result, the 
disqualified person effectively transferred property other than cash or 
cash equivalents.
    (3) Special rule relating to nonqualified deferred compensation. If 
an excess benefit transaction results, in whole or in part, from the 
vesting (as described in Sec. 53.4958-1(e)(2)) of benefits provided 
under a nonqualified deferred compensation plan, then, to the extent 
that such benefits have not yet been distributed to the disqualified 
person, the disqualified person may correct the portion of the excess 
benefit resulting from the undistributed deferred compensation by 
relinquishing any right to receive the excess portion of the 
undistributed deferred compensation (including any earnings thereon).
    (4) Return of specific property--(i) In general. A disqualified 
person may, with the agreement of the applicable tax-exempt 
organization, make a payment by returning specific property previously 
transferred in the excess benefit transaction. In this case, the 
disqualified person is treated as making a payment equal to the lesser 
of--
    (A) The fair market value of the property determined on the date the 
property is returned to the organization; or
    (B) The fair market value of the property on the date the excess 
benefit transaction occurred.
    (ii) Payment not equal to correction amount. If the payment 
described in paragraph (b)(4)(i) of this section is less than the 
correction amount (as described in paragraph (c) of this section), the 
disqualified person must make an additional cash payment to the 
organization equal to the difference. Conversely, if the payment 
described in paragraph (b)(4)(i) of this section exceeds the correction 
amount (as described in paragraph (c) of this section), the organization 
may make a cash payment to the disqualified person equal to the 
difference.
    (iii) Disqualified person may not participate in decision. Any 
disqualified person who received an excess benefit from the excess 
benefit transaction may not participate in the applicable tax-exempt 
organization's decision whether to accept the return of specific 
property under paragraph (b)(4)(i) of this section.
    (c) Correction amount. The correction amount with respect to an 
excess benefit transaction equals the sum of the excess benefit (as 
defined in Sec. 53.4958-1(b)) and interest on the excess benefit. The 
amount of the interest charge for purposes of this section is determined 
by multiplying the excess benefit by an interest rate, compounded 
annually, for the period from the date the excess

[[Page 246]]

benefit transaction occurred (as defined in Sec. 53.4958-1(e)) to the 
date of correction. The interest rate used for this purpose must be a 
rate that equals or exceeds the applicable Federal rate (AFR), 
compounded annually, for the month in which the transaction occurred. 
The period from the date the excess benefit transaction occurred to the 
date of correction is used to determine whether the appropriate AFR is 
the Federal short-term rate, the Federal mid-term rate, or the Federal 
long-term rate. See section 1274(d)(1)(A).
    (d) Correction where contract has been partially performed. If the 
excess benefit transaction arises under a contract that has been 
partially performed, termination of the contractual relationship between 
the organization and the disqualified person is not required in order to 
correct. However, the parties may need to modify the terms of any 
ongoing contract to avoid future excess benefit transactions.
    (e) Correction in the case of an applicable tax-exempt organization 
that has ceased to exist, or is no longer tax-exempt--(1) In general. A 
disqualified person must correct an excess benefit transaction in 
accordance with this paragraph where the applicable tax-exempt 
organization that engaged in the transaction no longer exists or is no 
longer described in section 501(c)(3) or (4) and exempt from tax under 
section 501(a).
    (2) Section 501(c)(3) organizations. In the case of an excess 
benefit transaction with a section 501(c)(3) applicable tax-exempt 
organization, the disqualified person must pay the correction amount, as 
defined in paragraph (c) of this section, to another organization 
described in section 501(c)(3) and exempt from tax under section 501(a) 
in accordance with the dissolution clause contained in the constitutive 
documents of the applicable tax-exempt organization involved in the 
excess benefit transaction, provided that--
    (i) The organization receiving the correction amount is described in 
section 170(b)(1)(A) (other than in section 170(b)(1)(A)(vii) and 
(viii)) and has been in existence and so described for a continuous 
period of at least 60 calendar months ending on the correction date;
    (ii) The disqualified person is not also a disqualified person (as 
defined in Sec. 53.4958-3) with respect to the organization receiving 
the correction amount; and
    (iii) The organization receiving the correction amount does not 
allow the disqualified person (or persons described in Sec. 53.4958-
3(b) with respect to that person) to make or recommend any grants or 
distributions by the organization.
    (3) Section 501(c)(4) organizations. In the case of an excess 
benefit transaction with a section 501(c)(4) applicable tax-exempt 
organization, the disqualified person must pay the correction amount, as 
defined in paragraph (c) of this section, to a successor section 
501(c)(4) organization or, if no tax-exempt successor, to any 
organization described in section 501(c)(3) or (4) and exempt from tax 
under section 501(a), provided that the requirements of paragraphs 
(e)(2)(i) through (iii) of this section are satisfied (except that the 
requirement that the organization receiving the correction amount is 
described in section 170(b)(1)(A) (other than in section 
170(b)(1)(A)(vii) and (viii)) shall not apply if the organization is 
described in section 501(c)(4)).
    (f) Examples. The following examples illustrate the principles of 
this section describing the requirements of correction:

    Example 1. W is an applicable tax-exempt organization for purposes 
of section 4958. D is a disqualified person with respect to W. W 
employed D in 1999 and made payments totaling $12t to D as compensation 
throughout the taxable year. The fair market value of D's services in 
1999 was $7t. Thus, D received excess compensation in the amount of $5t, 
the excess benefit for purposes of section 4958. In accordance with 
Sec. 53.4958-1(e)(1), the excess benefit transaction with respect to 
the series of compensatory payments during 1999 is deemed to occur on 
December 31, 1999, the last day of D's taxable year. In order to correct 
the excess benefit transaction on June 30, 2002, D must pay W, in cash 
or cash equivalents, excluding payment with a promissory note, $5t (the 
excess benefit) plus interest on $5t for the period from the date the 
excess benefit transaction occurred to the date of correction (i.e., 
December 31, 1999, to June 30, 2002). Because this period is not more 
than three years, the interest rate D must use to determine the interest 
on the excess benefit must equal or exceed the short-term AFR, 
compounded annually, for

[[Page 247]]

December, 1999 (5.74%, compounded annually).
    Example 2. X is an applicable tax-exempt organization for purposes 
of section 4958. B is a disqualified person with respect to X. On 
January 1, 2000, B paid X $6v for Property F. Property F had a fair 
market value of $10v on January 1, 2000. Thus, the sales transaction on 
that date provided an excess benefit to B in the amount of $4v. In order 
to correct the excess benefit on July 5, 2005, B pays X, in cash or cash 
equivalents, excluding payment with a promissory note, $4v (the excess 
benefit) plus interest on $4v for the period from the date the excess 
benefit transaction occurred to the date of correction (i.e., January 1, 
2000, to July 5, 2005). Because this period is over three but not over 
nine years, the interest rate B must use to determine the interest on 
the excess benefit must equal or exceed the mid-term AFR, compounded 
annually, for January, 2000 (6.21%, compounded annually).
    Example 3. The facts are the same as in Example 2, except that B 
offers to return Property F. X agrees to accept the return of Property 
F, a decision in which B does not participate. Property F has declined 
in value since the date of the excess benefit transaction. On July 5, 
2005, the property has a fair market value of $9v. For purposes of 
correction, B's return of Property F to X is treated as a payment of 
$9v, the fair market value of the property determined on the date the 
property is returned to the organization. If $9v is greater than the 
correction amount ($4v plus interest on $4v at a rate that equals or 
exceeds 6.21%, compounded annually, for the period from January 1, 2000, 
to July 5, 2005), then X may make a cash payment to B equal to the 
difference.
    Example 4. The facts are the same as in Example 3, except that 
Property F has increased in value since January 1, 2000, the date the 
excess benefit transaction occurred, and on July 5, 2005, has a fair 
market value of $13v. For purposes of correction, B's return of Property 
F to X is treated as a payment of $10v, the fair market value of the 
property on the date the excess benefit transaction occurred. If $10v is 
greater than the correction amount ($4v plus interest on $4v at a rate 
that equals or exceeds 6.21%, compounded annually, for the period from 
January 1, 2000, to July 5, 2005), then X may make a cash payment to B 
equal to the difference.
    Example 5. The facts are the same as in Example 2. Assume that the 
correction amount B paid X in cash on July 5, 2005, was $5.58v. On July 
4, 2005, X loaned $5.58v to B, in exchange for a promissory note signed 
by B in the amount of $5.58v, payable with interest at a future date. 
These facts indicate that B engaged in the loan transaction to 
circumvent the requirement of this section that (except as provided in 
paragraph (b)(3) or (4) of this section), the correction amount must be 
paid only in cash or cash equivalents. As a result, the Commissioner may 
determine that B effectively transferred property other than cash or 
cash equivalents, and therefore did not satisfy the correction 
requirements of this section.

[T.D. 8978, 67 FR 3083, Jan. 23, 2002]



Sec. 53.4958-8  Special rules.

    (a) Substantive requirements for exemption still apply. Section 4958 
does not affect the substantive standards for tax exemption under 
section 501(c)(3) or (4), including the requirements that the 
organization be organized and operated exclusively for exempt purposes, 
and that no part of its net earnings inure to the benefit of any private 
shareholder or individual. Thus, regardless of whether a particular 
transaction is subject to excise taxes under section 4958, existing 
principles and rules may be implicated, such as the limitation on 
private benefit. For example, transactions that are not subject to 
section 4958 because of the initial contract exception described in 
Sec. 53.4958-4(a)(3) may, under certain circumstances, jeopardize the 
organization's tax-exempt status.
    (b) Interaction between section 4958 and section 7611 rules for 
church tax inquiries and examinations. The procedures of section 7611 
will be used in initiating and conducting any inquiry or examination 
into whether an excess benefit transaction has occurred between a church 
and a disqualified person. For purposes of this rule, the reasonable 
belief required to initiate a church tax inquiry is satisfied if there 
is a reasonable belief that a section 4958 tax is due from a 
disqualified person with respect to a transaction involving a church. 
See Sec. 301.7611-1 Q&A 19 of this chapter.
    (c) Other substantiation requirements. These regulations, in Sec. 
53.4958-4(c)(3), set forth specific substantiation rules. Compliance 
with the specific substantiation rules of that section does not relieve 
applicable tax-exempt organizations of other rules and requirements of 
the Internal Revenue Code, regulations, Revenue Rulings, and other 
guidance issued by the Internal Revenue Service (including the 
substantiation rules of sections 162 and 274, or Sec. 1.6001-1(a) and 
(c) of this chapter).

[T.D. 8978, 67 FR 3083, Jan. 23, 2002]

[[Page 248]]



Sec. 53.4961-1  Abatement of second tier taxes for correction within 
correction period.

    If any taxable event is corrected during the correction period for 
the event, then any second tier tax imposed with respect to the event 
shall not be assessed. If the tax has been assessed, it shall be abated. 
If the tax has been collected, it shall be credited or refunded as an 
overpayment. For purposes of this section, the tax imposed includes 
interest, additions to the tax and additional amounts. For definitions 
of the terms second tier tax, taxable event, correct, and correction 
period, see Sec. 53.4963-1.



Sec. 53.4961-2  Court proceedings to determine liability for second 
tier tax.

    (a) Introduction. Under section 4961 (b) and (c), the period of 
limitations on collection may be suspended and assessment or collection 
of first or second tier tax may be prohibited during the pendency of 
administrative and judicial proceedings conducted to determine a 
taxpayer's liability for second tier tax. This section provides rules 
relating to the suspension of the limitations period and the 
prohibitions on assessment and collection. In addition, this section 
describes the administrative and judicial proceedings to which these 
rules apply.
    (b) Initial proceeding--(1) Defined. For purposes of subpart K, an 
initial proceeding means a proceeding described in subparagraph (2) or 
(3).
    (2) Tax Court proceeding before assessment. A proceeding is 
described in this subparagraph (2) if it is a proceeding with respect to 
the taxpayer's liability for second tier tax and is commenced in 
accordance with section 6213 (a).
    (3) Refund proceeding commenced before correction period ends. A 
proceeding is described in this subparagraph (3) if it is a proceeding 
commenced under section 7422, in accordance with the provisions of Sec. 
53.4963-1(e) (4) and (5) (relating to prerequisites to extension of the 
correction period during certain refund proceedings), and with respect 
to the taxpayer's liability for second tier tax.
    (c) Supplemental proceeding--(1) Jurisdiction. If a determination in 
an initial proceeding that a taxpayer is liable for a second tier tax 
has become final, the court in which the initial proceeding was 
commenced shall have jurisdiction to conduct any necessary supplemental 
proceeding to determine whether the taxable event was corrected during 
the correction period.
    (2) Time for beginning proceeding. The time for beginning a 
supplemental proceeding begins on the day after a determination in an 
initial proceeding becomes final and ends on the 90th day after the last 
day of the correction period.
    (d) Restriction on assessment during Tax Court proceeding. If a 
supplemental proceeding described in section 4961 (b) and Sec. 53.4961-
2(c) is commenced in the Tax Court, the provisions of the second and 
third sentences of section 6213(a) and the first and third sentences of 
Sec. 301.6213-1(a)(2) apply with respect to a deficiency in second tier 
tax until the decision of the Tax Court in the supplemental proceeding 
is final.
    (e) Suspension of period of collection for second tier tax--(1) 
Scope. Except as provided in subparagraph (6), this paragraph (e) 
applies to the second tier tax assessed with respect to a taxable event 
if a claim described in subparagraph (2) is filed.
    (2) Claim for refund. A claim for refund is described in this 
subparagraph (2) if, no later than 90 days after the day on which the 
second tier tax is assessed with respect to a taxable event, the 
taxpayer--
    (i) Pays the full amount of first tier tax for the taxable period, 
and
    (ii) Files a claim for refund of the amount paid.
    (3) Collection prohibited. No levy or proceeding in court for the 
collection of the second tier tax shall be made, begun, or prosecuted 
until the end of the collection prohibition period described in 
subparagraph (5). Notwithstanding section 7421(a), the collection by 
levy or proceeding may be enjoined during the collection prohibition 
period by a proceeding in the proper court.
    (4) Suspension of running of period of limitations on collection. 
With respect to a second tier tax to which this paragraph (e) applies, 
the running of the period of limitations provided in section 6502 
(relating to collection of tax by levy or by a proceeding in court) 
shall

[[Page 249]]

be suspended for the collection prohibition period described in 
subparagraph (5).
    (5) Collection prohibition period. The collection prohibition period 
begins on the day the second tier tax is assessed and ends on the latest 
of:
    (i) The day a decision in a refund proceeding commenced before the 
91st day after denial of the claim described in subparagraph (2) of this 
paragraph (including any supplemental proceeding under Sec. 53.4961-
2(c)) becomes final;
    (ii) The 90th day after the claim referred to in subparagraph (2) is 
denied; or
    (iii) The 90th day after the second tier tax is assessed.
    (6) Jeopardy collection. If the Secretary makes a finding that the 
collection of the second tier tax is in jeopardy, nothing in this 
paragraph (e) shall prevent the immediate collection of such tax.
    (f) Finality--(1) Tax Court proceeding. For purposes of this subpart 
K, section 7481 applies in determining when a decision in a Tax Court 
proceeding becomes final.
    (2) Refund proceeding. For purposes of this subpart K, Sec. 
301.7422-1 applies in determining when a decision in a refund proceeding 
becomes final.



Sec. 53.4963-1  Definitions.

    (a) First tier tax. For purposes of this subpart K, the term first 
tier tax means any tax imposed by subsection (a) of section 4941, 4942, 
4943, 4944, 4945, 4951, 4952, 4955, 4958, 4971, or 4975. A first tier 
tax may also be referred to as an ``initial tax'' in parts 53 and 54.
    (b) Second tier tax. For purposes of this subpart K, the term second 
tier tax means any tax imposed by subsection (b) of section 4941, 4942, 
4943, 4944, 4945, 4951, 4952, 4955, 4958, 4971, or 4975. A second tier 
tax may also be referred to as an ``additional tax'' in parts 53 and 54.
    (c) Taxable event. For purposes of this subpart K, the term taxable 
event means any act, or failure to act, giving rise to liability for tax 
under section 4941, 4942, 4943, 4944, 4945, 4951, 4952, 4955, 4958, 
4971, or 4975.
    (d) Correct--(1) In general. Except as provided in subparagraph (2), 
the term correct has the same meaning for purposes of this subpart K as 
in the section which imposes the second tier tax or the regulations 
thereunder.
    (2) Special rules. The term correct means--
    (i) For a second tier tax imposed by section 4942(b), reducing the 
amount of the undistributed income to zero,
    (ii) For a second tier tax imposed by section 4943(b), reducing the 
amount of the excess business holdings to zero, and
    (iii) For a second tier tax imposed by section 4944(b), removing the 
investment from jeopardy.
    (e) Correction period--(1) In general. The correction period with 
respect to any taxable event shall begin with the date on which the 
taxable event occurs and shall end 90 days after the date of mailing of 
a notice of deficiency under section 6212 with respect to the second 
tier tax imposed with respect to the taxable event.
    (2) Extensions of correction period. The correction period referred 
to in subparagraph (1) of this paragraph shall be extended by any period 
in which a deficiency cannot be assessed under section 6213(a). In 
addition, the correction period referred to in subparagraph (1) of this 
paragraph (e) shall be extended in accordance with subparagraph (3), 
(4), and (5) of this paragraph except that subparagraph (4), or (5) 
shall not operate to extend a correction period with respect to which a 
taxpayer has filed a petition with the United States Tax Court for 
redetermination of a deficiency within the time prescribed by section 
6213(a).
    (3) Extensions by Commissioner. The correction period referred to in 
subparagraph (1) of this paragraph may be extended by any period which 
the Commissioner determines is reasonable and necessary to bring about 
correction (including, for taxes imposed by section 4975, equitable 
relief sought by the Secretary of Labor) of the taxable event. The 
Commissioner ordinarily will not extend the correction period unless the 
following factors are present.
    (i) The taxpayer on whom the second tier tax is imposed, the 
Secretary of Labor (for taxes imposed by section 4975), or an 
appropriate State officer

[[Page 250]]

(as defined in section 6104(c)(2)) is actively seeking in good faith to 
correct the taxable event;
    (ii) Adequate corrective action cannot reasonably be expected to 
result during the unextended correction period;
    (iii) For taxes imposed by section 4975, the Secretary of Labor 
requests the extension because subdivision (ii) applies; and
    (iv) For taxes imposed by chapter 42 (other than taxes imposed by 
section 4940), the taxable event appears to have been an isolated 
occurrence so that it appears unlikely that similar taxable events will 
occur in the future.
    (4) Extension for payment of first tier tax. If, within the 
unexpected correction period, the taxpayer pays the full amount of the 
first tier tax imposed with respect to the taxable event the 
Commissioner shall extend the correction period to the later of--
    (i) Ninety days after the payment of the first tier tax, or
    (ii) The last day of the correction period determined without regard 
to this paragraph.
    (5) Extensions for filing claim for refund or refund suit. If prior 
to the expiration of the correction period (including extensions) a 
claim for refund is filed with respect to payment of the full amount of 
the first tier tax imposed with respect to the taxable event, the 
Commissioner shall extend the correction period during the pendency of 
the claim plus an additional 90 days. If within that time a suit or 
proceeding referred to in section 7422(g) with respect to the claim is 
filed, the Commissioner shall extend the correction period until the 
determination in the suit for refund (determined without regard to a 
supplemental proceeding under section 4861(b)) is final, determined 
under Sec. 301.7422-2(a).
    (6) End of correction period if waiver accepted. If the notice of 
deficiency referred to in paragraph (1) is not mailed because there is a 
waiver of the restrictions on assessment and collection of the 
deficiency or because the deficiency is paid, the correction period will 
end with the end of the collection prohibition period described in Sec. 
53.4961-2(e)(5).
    (7) Date on which taxable event occurs. For purposes of subparagraph 
(1), the taxable event shall be treated as occurring--
    (i) Under section 4942, on the first day of the taxable year for 
which there is undistributed income,
    (ii) Under section 4943, on the first day on which there are excess 
business holdings,
    (iii) Under section 4971, on the last day of the plan year in which 
there is an accumulated funding deficiency, and
    (iv) In all other cases, the date on which the event occurred.
    (f) Effective date. The provisions of this subpart K are effective 
with respect to second tier taxes assessed after December 24, 1980. The 
preceding sentence shall not be construed to permit the assessment of a 
tax in a case to which, on December 24, 1980, the doctrine of res 
judicata applied.

[T.D. 8084, 51 FR 16303, May 2, 1986; 51 FR 17732, May 15, 1986, as 
amended by T.D. 8628, 60 FR 62212, Dec. 5, 1995; T.D. 8920, 66 FR 2171, 
Jan. 10, 2001]



Sec. 53.4965-1  Overview.

    (a) Entity-level excise tax. Section 4965 imposes two excise taxes 
with respect to certain tax shelter transactions to which tax-exempt 
entities are parties. Section 4965(a)(1) imposes an entity-level excise 
tax on certain tax-exempt entities that are parties to ``prohibited tax 
shelter transactions,'' as defined in section 4965(e). See Sec. 
53.4965-2 for the discussion of covered tax-exempt entities. See Sec. 
53.4965-3 for the definition of prohibited tax shelter transactions. See 
Sec. 53.4965-4 for the definition of tax-exempt party to a prohibited 
tax shelter transaction. The entity-level excise tax under section 
4965(a)(1) is imposed on a specified percentage of the entity's net 
income or proceeds that are attributable to the transaction for the 
relevant tax year (or a period within that tax year). The rate of tax 
depends on whether the entity knew or had reason to know that the 
transaction was a prohibited tax shelter transaction at the time the 
entity became a party to the transaction. See Sec. 53.4965-7(a) for the 
discussion of the entity-level excise tax under section 4965(a)(1). See

[[Page 251]]

Sec. 53.4965-6 for the discussion of ``knowing or having reason to 
know.'' See Sec. 53.4965-8 for the definition of net income and 
proceeds and the standard for allocating net income and proceeds that 
are attributable to a prohibited tax shelter transaction to various 
periods.
    (b) Manager-level excise tax. Section 4965(a)(2) imposes a manager-
level excise tax on ``entity managers,'' as defined in section 4965(d), 
of tax-exempt entities who approve the entity as a party (or otherwise 
cause the entity to be a party) to a prohibited tax shelter transaction 
and know or have reason to know, at the time the tax-exempt entity 
enters into the transaction, that the transaction is a prohibited tax 
shelter transaction. See Sec. 53.4965-5 for the definition of entity 
manager and the meaning of ``approving or otherwise causing,'' and Sec. 
53.4965-6 for the discussion of ``knowing or having reason to know.'' 
See Sec. 53.4965-7(b) for the discussion of the manager-level excise 
tax under section 4965(a)(2).
    (c) Effective/applicability dates. See Sec. 53.4965-9 for the 
discussion of the relevant effective and applicability dates.

[T.D. 9492, 75 FR 38702, July 6, 2010]



Sec. 53.4965-2  Covered tax-exempt entities.

    (a) In general. Under section 4965(c), the term ``tax-exempt 
entity'' refers to entities that are described in sections 501(c), 
501(d), or 170(c) (other than the United States), Indian tribal 
governments (within the meaning of section 7701(a)(40)), and tax-
qualified pension plans, individual retirement arrangements and similar 
tax-favored savings arrangements that are described in sections 
4979(e)(1), (2) or (3), 529, 457(b), or 4973(a). The tax-exempt entities 
referred to in section 4965(c) are divided into two broad categories, 
non-plan entities and plan entities.
    (b) Non-plan entities. Non-plan entities are--
    (1) Entities described in section 501(c);
    (2) Religious or apostolic associations or corporations described in 
section 501(d);
    (3) Entities described in section 170(c), including states, 
possessions of the United States, the District of Columbia, political 
subdivisions of states and political subdivisions of possessions of the 
United States (but not including the United States); and
    (4) Indian tribal governments within the meaning of section 
7701(a)(40).
    (c) Plan entities. Plan entities are--
    (1) Entities described in section 4979(e)(1) (qualified plans under 
section 401(a), including qualified cash or deferred arrangements under 
section 401(k) (including a section 401(k) plan that allows designated 
Roth contributions));
    (2) Entities described in section 4979(e)(2) (annuity plans 
described in section 403(a));
    (3) Entities described in section 4979(e)(3) (annuity contracts 
described in section 403(b), including a section 403(b) arrangement that 
allows Roth contributions);
    (4) Qualified tuition programs described in section 529;
    (5) Eligible deferred compensation plans under section 457(b) that 
are maintained by a governmental employer as defined in section 
457(e)(1)(A);
    (6) Arrangements described in section 4973(a) which include--
    (i) Individual retirement plans defined in section 408(a) and (b), 
including--
    (A) Simplified employee pensions (SEPs) under section 408(k);
    (B) Simple individual retirement accounts (SIMPLEs) under section 
408(p);
    (C) Deemed individual retirement accounts or annuities (IRAs) 
qualified under a qualified plan (deemed IRAs) under section 408(q); and
    (D) Roth IRAs under section 408A.
    (ii) Arrangements described in section 220(d) (Archer Medical 
Savings Accounts (MSAs));
    (iii) Arrangements described in section 403(b)(7) (custodial 
accounts treated as annuity contracts);
    (iv) Arrangements described in section 530 (Coverdell education 
savings accounts); and
    (v) Arrangements described in section 223(d) (health savings 
accounts (HSAs)).
    (d) Effective/applicability dates. See Sec. 53.4965-9 for the 
discussion of the relevant effective and applicability dates.

[T.D. 9492, 75 FR 38702, July 6, 2010; 75 46844, Aug. 4, 2010]

[[Page 252]]



Sec. 53.4965-3  Prohibited tax shelter transactions.

    (a) In general. Under section 4965(e), the term prohibited tax 
shelter transaction means--
    (1) Listed transactions within the meaning of section 6707A(c)(2), 
including subsequently listed transactions described in paragraph (b) of 
this section; and
    (2) Prohibited reportable transactions, which consist of the 
following reportable transactions within the meaning of section 
6707A(c)(1)--
    (i) Confidential transactions, as described in Sec. 1.6011-4(b)(3) 
of this chapter; or
    (ii) Transactions with contractual protection, as described in Sec. 
1.6011-4(b)(4) of this chapter.
    (b) Subsequently listed transactions. A subsequently listed 
transaction for purposes of section 4965 is a transaction that is 
identified by the Secretary as a listed transaction after the tax-exempt 
entity has entered into the transaction and that was not a prohibited 
reportable transaction (within the meaning of section 4965(e)(1)(C) and 
paragraph (a)(2) of this section) at the time the entity entered into 
the transaction.
    (c) Cross-reference. The determination of whether a transaction is a 
listed transaction or a prohibited reportable transaction for section 
4965 purposes shall be made under the law applicable to section 
6707A(c)(1) and (c)(2).
    (d) Effective/applicability dates. See Sec. 53.4965-9 for the 
discussion of the relevant effective and applicability dates.

[T.D. 9492, 75 FR 38702, July 6, 2010]



Sec. 53.4965-4  Definition of tax-exempt party to a prohibited tax 
shelter transaction.

    (a) In general. For purposes of sections 4965 and 6033(a)(2), a tax-
exempt entity is a party to a prohibited tax shelter transaction if the 
entity--
    (1) Facilitates a prohibited tax shelter transaction by reason of 
its tax-exempt, tax indifferent or tax-favored status; or
    (2) Is identified in published guidance, by type, class or role, as 
a party to a prohibited tax shelter transaction.
    (b) Published guidance may identify which tax-exempt entities, by 
type, class or role, will not be treated as a party to a prohibited tax 
shelter transaction.
    (c) Example. The following example illustrates the principle of 
paragraph (a)(1) of this section:

    Example. A tax-exempt entity enters into a transaction (Transaction 
A) with an S corporation. Transaction A is the same as or substantially 
similar to the transaction identified by the Secretary as a listed 
transaction in Notice 2004-30 (2004-1 CB 828). The tax-exempt entity's 
role in Transaction A is similar to the role of the tax-exempt party, as 
described in Notice 2004-30. Under the terms of the transaction, as 
described in Notice 2004-30, the tax-exempt entity receives the S 
corporation stock and purports to aid the S corporation and its 
shareholders in avoiding taxable income. The tax-exempt entity 
facilitates Transaction A by reason of its tax-exempt, tax indifferent 
or tax-favored status. Accordingly, the tax-exempt entity is a party to 
Transaction A for purposes of sections 4965 and 6033(a)(2). See Sec. 
601.601(d)(2)(ii)(b) of this chapter.

    (d) Effective/applicability dates. See Sec. 53.4965-9 for the 
discussion of the relevant effective and applicability dates.

[T.D. 9492, 75 FR 38702, July 6, 2010]



Sec. 53.4965-5  Entity managers and related definitions.

    (a) Entity manager of a non-plan entity--(1) In general. Under 
section 4965(d)(1), an entity manager of a non-plan entity is--
    (i) A person with the authority or responsibility similar to that 
exercised by an officer, director, or trustee of an organization (that 
is, the non-plan entity); and
    (ii) With respect to any act, the person who has final authority or 
responsibility (either individually or as a member of a collective body) 
with respect to such act.
    (2) Definition of officer. For purposes of paragraph (a)(1)(i) of 
this section, a person is considered to be an officer of the non-plan 
entity (or to have similar authority or responsibility) if the person--
    (i) Is specifically designated as such under the certificate of 
incorporation, by-laws, or other constitutive documents of the non-plan 
entity; or

[[Page 253]]

    (ii) Regularly exercises general authority to make administrative or 
policy decisions on behalf of the non-plan entity.
    (3) Exception for acts requiring approval by a superior. With 
respect to any act, any person is not described in paragraph (a)(2)(ii) 
of this section if the person has authority merely to recommend 
particular administrative or policy decisions, but not to implement them 
without approval of a superior.
    (4) Delegation of authority. A person is an entity manager of a non-
plan entity within the meaning of paragraph (a)(1)(ii) of this section 
if, with respect to any prohibited tax shelter transaction, such person 
has been delegated final authority or responsibility with respect to 
such transaction (including by transaction type or dollar amount) by a 
person described in paragraph (a)(1)(i) of this section or the governing 
board of the entity. For example, an investment manager is an entity 
manager with respect to a prohibited tax shelter transaction if the non-
plan entity's governing body delegated to the investment manager the 
final authority to make certain investment decisions and, in the 
exercise of that authority, the manager committed the entity to the 
transaction. To be considered an entity manager of a non-plan entity 
within the meaning of paragraph (a)(1)(ii) of this section, a person 
need not be an employee of the entity. A person is not described in 
paragraph (a)(1)(ii) of this section if the person is merely 
implementing a decision made by a superior.
    (b) Entity manager of a plan entity--(1) In general. Under section 
4965(d)(2), an entity manager of a plan entity is the person who 
approves or otherwise causes the entity to be a party to the prohibited 
tax shelter transaction.
    (2) Special rule for plan participants and beneficiaries who have 
investment elections--(i) Fully self-directed plans or arrangements. In 
the case of a fully self-directed qualified plan, IRA, or other savings 
arrangement (including a case where a plan participant or beneficiary is 
given a list of prohibited investments, such as collectibles), if the 
plan participant or beneficiary selected a certain investment and, 
therefore, approved the plan entity to become a party to a prohibited 
tax shelter transaction, the plan participant or the beneficiary is an 
entity manager.
    (ii) Plans or arrangements with limited investment options. In the 
case of a qualified plan, IRA, or other savings arrangement where a plan 
participant or beneficiary is offered a limited number of investment 
options from which to choose, the person responsible for determining the 
pre-selected investment options is an entity manager and the plan 
participant or the beneficiary generally is not an entity manager.
    (c) Meaning of ``approves or otherwise causes''--(1) In general. A 
person is treated as approving or otherwise causing a tax-exempt entity 
to become a party to a prohibited tax shelter transaction if the person 
has the authority to commit the entity to the transaction, either 
individually or as a member of a collective body, and the person 
exercises that authority.
    (2) Collective bodies. If a person shares the authority described in 
paragraph (c)(1) of this section as a member of a collective body (for 
example, board of trustees or committee), the person will be considered 
to have exercised such authority if the person voted in favor of the 
entity becoming a party to the transaction. However, a member of the 
collective body will not be treated as having exercised the authority 
described in paragraph (c)(1) of this section if he or she voted against 
a resolution that constituted approval or an act that caused the tax-
exempt entity to be a party to a prohibited tax shelter transaction, 
abstained from voting for such approval, or otherwise failed to vote in 
favor of such approval.
    (3) Exceptions--(i) Successor in interest. If a tax-exempt entity 
that is a party to a prohibited tax shelter transaction is dissolved, 
liquidated, or merged into a successor entity, an entity manager of the 
successor entity will not, solely by reason of the reorganization, be 
treated as approving or otherwise causing the successor entity to become 
a party to a prohibited tax shelter transaction, provided that the 
reorganization of the tax-exempt entity does not result in a material 
change to the terms of the transaction. For purposes of this paragraph 
(c)(3)(i), a material

[[Page 254]]

change includes an extension or renewal of the agreement (other than an 
extension or renewal that results from another party to the transaction 
unilaterally exercising an option granted by the agreement) or a more 
than incidental change to any payment under the agreement. A change for 
the sole purpose of substituting the successor entity for the original 
tax-exempt party is not a material change.
    (ii) Exercise or nonexercise of options. Nonexercise of an option 
pursuant to a transaction involving the tax-exempt entity generally will 
not constitute an act of approving or causing the entity to be a party 
to the transaction. If, pursuant to a transaction involving the tax-
exempt entity, the entity manager exercises an option (such as a 
repurchase option), the entity manager will not be subject to the entity 
manager-level tax if the exercise of the option does not result in the 
tax-exempt entity becoming a party to a second transaction that is a 
prohibited tax shelter transaction.
    (4) Example. The following example illustrates the principles of 
paragraph (c)(3)(ii) of this section:

    Example. In a sale-in, lease-out (SILO) transaction described in 
Notice 2005-13 (2005-1 CB 630), X, which is a non-plan entity, has 
purported to sell property to Y, a taxable entity and lease it back for 
a term of years. At the end of the basic lease term, X has the option of 
``repurchasing'' the property from Y for a predetermined purchase price, 
with funds that have been set aside at the inception of the transaction 
for that purpose. The entity manager, by deciding to exercise or not 
exercise the ``repurchase'' option is not approving or otherwise causing 
the non-plan entity to become a party to a second prohibited tax shelter 
transaction. See Sec. 601.601(d)(2)(ii)(b) of this chapter.

    (5) Coordination with the reason-to-know standard. The determination 
that an entity manager approved or caused a tax-exempt entity to be a 
party to a prohibited tax shelter transaction, by itself, does not 
establish liability for the section 4965(a)(2) tax. For rules on 
determining whether an entity manager knew or had reason to know that 
the transaction was a prohibited tax shelter transaction, see Sec. 
53.4965-6(b).
    (d) Effective/applicability dates. See Sec. 53.4965-9 for the 
discussion of the relevant effective and applicability dates.

[T.D. 9492, 75 FR 38702, July 6, 2010; 75 FR 46844, Aug. 4, 2010]



Sec. 53.4965-6  Meaning of ``knows or has reason to know''.

    (a) Attribution to the entity. An entity will be treated as knowing 
or having reason to know for section 4965 purposes if one or more of its 
entity managers knew or had reason to know that the transaction was a 
prohibited tax shelter transaction at the time the entity manager(s) 
approved the entity as (or otherwise caused the entity to be) a party to 
the transaction. The entity shall be attributed the knowledge or reason 
to know of any entity manager described in Sec. 53.4965-5(a)(1)(i) even 
if that entity manager does not approve the entity as (or otherwise 
cause the entity to be) a party to the transaction.
    (b) Determining whether an entity manager knew or had reason to 
know--(1) In general. Whether an entity manager knew or had reason to 
know that a transaction is a prohibited tax shelter transaction is based 
on all facts and circumstances. In order for an entity manager to know 
or have reason to know that a transaction is a prohibited tax shelter 
transaction, the entity manager must have knowledge of sufficient facts 
that would lead a reasonable person to conclude that the transaction is 
a prohibited tax shelter transaction. An entity manager will be 
considered to have ``reason to know'' if a reasonable person in the 
entity manager's circumstances would conclude that the transaction was a 
prohibited tax shelter transaction based on all the facts reasonably 
available to the manager at the time of approving the entity as (or 
otherwise causing the entity to be) a party to the transaction. Factors 
that will be considered in determining whether a reasonable person in 
the entity manager's circumstances would conclude that the transaction 
was a prohibited tax shelter transaction include, but are not limited 
to--
    (i) The presence of tax shelter indicia (see paragraph (b)(2) of 
this section);
    (ii) Whether the entity manager received a disclosure statement 
prior to

[[Page 255]]

the consummation of the transaction indicating that the transaction may 
be a prohibited tax shelter transaction (see paragraph (b)(3) of this 
section); and
    (iii) Whether the entity manager made appropriate inquiries into the 
transaction (see paragraph (b)(4) of this section).
    (2) Tax-shelter indicia. The presence of indicia that a transaction 
is a tax shelter will be treated as an indication that the entity 
manager knew or had reason to know that the transaction was a prohibited 
tax shelter transaction. Tax shelter indicia include but are not limited 
to--
    (i) The transaction is extraordinary for the entity considering 
prior investment activity;
    (ii) The transaction promises an economic return for the 
organization that is exceptional considering the amount invested by, the 
participation of, or the absence of risk to the organization; or
    (iii) The transaction is of significant size relative to the 
receipts of the entity.
    (3) Effect of disclosure statements. Receipt by an entity manager of 
a statement, including a statement described in section 6011(g), in 
advance of a transaction that the transaction may be a prohibited tax 
shelter transaction (or a statement that a partnership, hedge fund or 
other investment conduit may engage in a prohibited tax shelter 
transaction in the future) is a factor relevant in the determination of 
whether the entity manager knew or had reason to know that the 
transaction is a prohibited transaction. However, an entity manager will 
not be treated as knowing or having reason to know that the transaction 
was a prohibited tax shelter transaction solely because the entity 
manager receives such a disclosure.
    (4) Appropriate inquiries. What inquiries are appropriate will be 
determined from the facts and circumstances of each case. For example, 
if one or more tax shelter indicia are present or if an entity manager 
receives a disclosure statement described in paragraph (b)(3) of this 
section, an entity manager has a responsibility to inquire further 
whether the transaction is a prohibited tax shelter transaction.
    (c) Reliance on professional advice--(1) In general. An entity 
manager is not required to obtain the advice of a professional tax 
advisor to establish that the entity manager made appropriate inquiries. 
Moreover, not seeking professional advice, by itself, shall not give 
rise to an inference that the entity manager had reason to know that a 
transaction is a prohibited tax shelter transaction.
    (2) Reliance on written opinion of professional tax advisor. An 
entity manager may establish that he or she did not have a reason to 
know that a transaction was a prohibited tax shelter transaction at the 
time the tax-exempt entity entered into the transaction if the entity 
manager reasonably, and in good faith, relied on the written opinion of 
a professional tax advisor. Reliance on the written opinion of a 
professional tax advisor establishes that the entity manager did not 
have reason to know if, taking into account all the facts and 
circumstances, the reliance was reasonable and the entity manager acted 
in good faith. For example, the entity manager's education, 
sophistication, and business experience will be relevant in determining 
whether the reliance was reasonable and made in good faith. In no event 
will an entity manager be considered to have reasonably relied in good 
faith on an opinion unless the requirements of this paragraph (c)(2) are 
satisfied. The fact that these requirements are satisfied, however, will 
not necessarily establish that the entity manager reasonably relied on 
the opinion in good faith. For example, reliance may not be reasonable 
or in good faith if the entity manager knew, or reasonably should have 
known, that the advisor lacked knowledge in the relevant aspects of 
Federal tax law.
    (i) All facts and circumstances considered. The advice must be based 
upon all pertinent facts and circumstances and the law as it relates to 
those facts and circumstances. The requirements of this paragraph (c)(2) 
are not satisfied if the entity manager fails to disclose a fact that it 
knows, or reasonably should know, is relevant to determining whether the 
transaction is a prohibited tax shelter transaction.

[[Page 256]]

    (ii) No unreasonable assumptions. The advice must not be based on 
unreasonable factual or legal assumptions (including assumptions as to 
future events) and must not unreasonably rely on the representations, 
statements, findings, or agreements of the entity manager or any other 
person (including another party to the transaction or a material advisor 
within the meaning of sections 6111 and 6112).
    (iii) ``More likely than not'' opinion. The written opinion of the 
professional tax advisor must apply the appropriate law to the facts 
and, based on this analysis, must conclude that the transaction was not 
a prohibited tax shelter transaction at a ``more likely than not'' level 
of certainty at the time the entity manager approved the entity (or 
otherwise caused the entity) to be a party to the transaction.
    (3) Special rule. An entity manager`s reliance on a written opinion 
of a professional tax advisor will not be considered reasonable if the 
advisor is, or is related to a person who is, a material advisor with 
respect to the transaction within the meaning of sections 6111 and 6112.
    (d) Subsequently listed transactions. An entity manager will not be 
treated as knowing or having reason to know that a transaction (other 
than a prohibited reportable transaction as defined in section 
4965(e)(1)(C) and Sec. 53.4965-3(a)(2)) is a prohibited tax shelter 
transaction if the entity enters into the transaction before the date on 
which the transaction is identified by the Secretary as a listed 
transaction.
    (e) Effective/applicability dates. See Sec. 53.4965-9 for the 
discussion of the relevant effective and applicability dates.

[T.D. 9492, 75 FR 38702, July 6, 2010]



Sec. 53.4965-7  Taxes on prohibited tax shelter transactions.

    (a) Entity-level taxes--(1) In general. Entity-level excise taxes 
apply to non-plan entities (as defined in Sec. 53.4965-2(b)) that are 
parties to prohibited tax shelter transactions.
    (i) Prohibited tax shelter transactions other than subsequently 
listed transactions--(A) Amount of tax if the entity did not know and 
did not have reason to know. If the tax-exempt entity did not know and 
did not have reason to know that the transaction was a prohibited tax 
shelter transaction at the time the entity entered into the transaction, 
the tax is the highest rate of tax under section 11 multiplied by the 
greater of--
    (1) The entity's net income with respect to the prohibited tax 
shelter transaction (after taking into account any tax imposed by 
Subtitle D, other than by this section, with respect to such 
transaction) for the taxable year; or
    (2) 75 percent of the proceeds received by the entity for the 
taxable year that are attributable to such transaction.
    (B) Amount of tax if the entity knew or had reason to know. If the 
tax-exempt entity knew or had reason to know that the transaction was a 
prohibited tax shelter transaction at the time the entity entered into 
the transaction, the tax is the greater of--
    (1) 100 percent of the entity's net income with respect to the 
transaction (after taking into account any tax imposed by Subtitle D, 
other than by this section, with respect to such transaction) for the 
taxable year; or
    (2) 75 percent of the proceeds received by the entity for the 
taxable year that are attributable to such transaction.
    (ii) Subsequently listed transactions--(A) In general. In the case 
of a subsequently listed transaction (as defined in section 4965(e)(2) 
and Sec. 53.4965-3(b)), the tax-exempt entity's income and proceeds 
attributable to the transaction are allocated between the period before 
the transaction became listed and the period beginning on the date the 
transaction became listed. See Sec. 53.4965-8 for the standard for 
allocating net income or proceeds to various periods. The tax for each 
taxable year is the highest rate of tax under section 11 multiplied by 
the greater of--
    (1) The entity's net income with respect to the subsequently listed 
transaction (after taking into account any tax imposed by Subtitle D, 
other than by this section, with respect to such transaction) for the 
taxable year that is allocable to the period beginning on the later of 
the date such transaction is identified by the Secretary as a listed 
transaction or the first day of the taxable year; or

[[Page 257]]

    (2) 75 percent of the proceeds received by the entity for the 
taxable year that are attributable to such transaction and allocable to 
the period beginning on the later of the date such transaction is 
identified by the Secretary as a listed transaction or the first day of 
the taxable year.
    (B) No increase in tax. The 100 percent tax under section 
4965(b)(1)(B) and Sec. 53.4965-7(a)(1)(i)(B) does not apply to any 
subsequently listed transaction (as defined in section 4965(e)(2) and 
Sec. 53.4965-3(b)) entered into by a tax-exempt entity before the date 
on which the transaction is identified by the Secretary as a listed 
transaction.
    (2) Taxable year. The excise tax imposed under section 4965(a)(1) 
applies for the taxable year in which the entity becomes a party to the 
prohibited tax shelter transaction and any subsequent taxable year for 
which the entity has net income or proceeds attributable to the 
transaction. A taxable year for tax-exempt entities is the calendar year 
or fiscal year, as applicable, depending on the basis on which the tax-
exempt entity keeps its books for Federal income tax purposes. If a tax-
exempt entity has not established a taxable year for Federal income tax 
purposes, the entity's taxable year for the purpose of determining the 
amount and timing of net income and proceeds attributable to a 
prohibited tax shelter transaction will be deemed to be the annual 
period the entity uses in keeping its books and records.
    (b) Manager-level taxes--(1) Amount of tax. If any entity manager 
approved or otherwise caused the tax-exempt entity to become a party to 
a prohibited tax shelter transaction and knew or had reason to know that 
the transaction was a prohibited tax shelter transaction, such entity 
manager is liable for the $20,000 tax. See Sec. 53.4965-5(d) for the 
meaning of approved or otherwise caused. See Sec. 53.4965-6 for the 
meaning of knew or had reason to know.
    (2) Timing of the entity manager tax. If a tax-exempt entity enters 
into a prohibited tax shelter transaction during a taxable year of an 
entity manager, then the entity manager that approved or otherwise 
caused the tax-exempt entity to become a party to the transaction is 
liable for the entity manager tax for that taxable year if the entity 
manager knew or had reason to know that the transaction was a prohibited 
tax shelter transaction.
    (3) Example. The application of paragraph (b)(2) of this section is 
illustrated by the following example:

    Example. The entity manager's taxable year is the calendar year. On 
December 1, 2006, the entity manager approved or otherwise caused the 
tax-exempt entity to become a party to a transaction that the entity 
manager knew or had reason to know was a prohibited tax shelter 
transaction. The tax-exempt entity entered into the transaction on 
January 31, 2007. The entity manager is liable for the entity manager 
level tax for the entity manager's 2007 taxable year, during which the 
tax-exempt entity entered into the prohibited tax shelter transaction.

    (4) Separate liability. If more than one entity manager approved or 
caused a tax-exempt entity to become a party to a prohibited tax shelter 
transaction while knowing (or having reason to know) that the 
transaction was a prohibited tax shelter transaction, then each such 
entity manager is separately (that is, not jointly and severally) liable 
for the entity manager-level tax with respect to the transaction.
    (c) Effective/applicability dates. See Sec. 53.4965-9 for the 
discussion of the relevant effective and applicability dates.

[T.D. 9492, 75 FR 38702, July 6, 2010]



Sec. 53.4965-8  Definition of net income and proceeds and standard for
allocating net income or proceeds to various periods.

    (a) In general. For purposes of section 4965(a), the amount and the 
timing of the net income and proceeds attributable to the prohibited tax 
shelter transaction will be computed in a manner consistent with the 
substance of the transaction. In determining the substance of listed 
transactions, the IRS will look to, among other items, the listing 
guidance and any subsequent guidance published in the Internal Revenue 
Bulletin relating to the transaction.
    (b) Definition of net income and proceeds--(1) Net income. A tax-
exempt entity's net income attributable to a prohibited tax shelter 
transaction is its gross income derived from the transaction reduced by 
those deductions

[[Page 258]]

that are attributable to the transaction and that would be allowed by 
chapter 1 of the Internal Revenue Code if the tax-exempt entity were 
treated as a taxable entity for this purpose, and further reduced by 
taxes imposed by Subtitle D, other than by this section, with respect to 
the transaction.
    (2) Proceeds--(i) Tax-exempt entities that facilitate the 
transaction by reason of their tax-exempt, tax indifferent or tax-
favored status. Solely for purposes of section 4965, in the case of a 
tax-exempt entity that is a party to the transaction by reason of Sec. 
53.4965-4(a)(1) of this chapter, the term proceeds means the gross 
amount of the tax-exempt entity's consideration for facilitating the 
transaction, not reduced for any costs or expenses attributable to the 
transaction. Published guidance with respect to a particular prohibited 
tax shelter transaction may designate additional amounts as proceeds 
from the transaction for section 4965 purposes.
    (ii) Treatment of gifts and contributions. To the extent not 
otherwise included in the definition of proceeds in paragraph (b)(2)(i) 
of this section, any amount that is a gift or a contribution to a tax-
exempt entity and is attributable to a prohibited tax shelter 
transaction will be treated as proceeds for section 4965 purposes, 
unreduced by any associated expenses.
    (c) Allocation of net income and proceeds--(1) In general. For 
purposes of section 4965(a), the net income and proceeds attributable to 
a prohibited tax shelter transaction must be allocated in a manner 
consistent with the tax-exempt entity's established method of accounting 
for Federal income tax purposes. If the tax-exempt entity has not 
established a method of accounting for Federal income tax purposes, 
solely for purposes of section 4965(a) the tax-exempt entity must use 
the cash receipts and disbursements method of accounting (cash method) 
provided for in section 446 of the Internal Revenue Code to determine 
the amount and timing of net income and proceeds attributable to a 
prohibited tax shelter transaction.
    (2) Special rule. If a tax-exempt entity has established a method of 
accounting other than the cash method, the tax-exempt entity may 
nevertheless use the cash method of accounting to determine the amount 
of the net income and proceeds--
    (i) Attributable to a prohibited tax shelter transaction entered 
into prior to the effective date of section 4965(a) tax and allocable to 
pre- and post-effective date periods; or
    (ii) Attributable to a subsequently listed transaction and allocable 
to pre- and post-listing periods.
    (d) Transition year rules. In the case of the taxable year that 
includes August 16, 2006 (the transition year), the IRS will treat the 
period beginning on the first day of the transition year and ending on 
August 15, 2006, and the period beginning on August 16, 2006, and ending 
on the last day of the transition year as short taxable years. This 
treatment is solely for purposes of allocating net income or proceeds 
under section 4965. The tax-exempt entity continues to file tax returns 
for the full taxable year, does not file tax returns with respect to 
these deemed short taxable years and does not otherwise take the short 
taxable years into account for Federal tax purposes. Accordingly, the 
net income or proceeds that are properly allocated to the transition 
year in accordance with this section will be treated as allocable to the 
period--
    (1) Ending on or before August 15, 2006 (and accordingly not subject 
to tax under section 4965(a)) to the extent such net income or proceeds 
would have been properly taken into account in accordance with this 
section by the tax-exempt entity in the deemed short year ending on 
August 15, 2006; and
    (2) Beginning after August 15, 2006 (and accordingly subject to tax 
under section 4965(a)) to the extent such income or proceeds would have 
been properly taken into account in accordance with this section by the 
tax-exempt entity in the short year beginning August 16, 2006.
    (e) Allocation to pre- and post-listing periods. If a transaction 
other than a prohibited reportable transaction (as defined in section 
4965(e)(1)(C) and Sec. 53.4965-3(a)(2)) to which the tax-exempt entity 
is a party is subsequently identified in published guidance as a listed 
transaction during a taxable year of the entity (the listing year) in

[[Page 259]]

which it has net income or proceeds attributable to the transaction, the 
net income or proceeds are allocated between the pre- and post-listing 
periods. The IRS will treat the period beginning on the first day of the 
listing year and ending on the day immediately preceding the date of the 
listing, and the period beginning on the date of the listing and ending 
on the last day of the listing year as short taxable years. This 
treatment is solely for purposes of allocating net income or proceeds 
under section 4965. The tax-exempt entity continues to file tax returns 
for the full taxable year, does not file tax returns with respect to 
these deemed short taxable years and does not otherwise take the short 
taxable years into account for Federal tax purposes. Accordingly, the 
net income or proceeds that are properly allocated to the listing year 
in accordance with this section will be treated as allocable to the 
period--
    (1) Ending before the date of the listing (and accordingly not 
subject to tax under section 4965(a)) to the extent such net income or 
proceeds would have been properly taken into account in accordance with 
this section by the tax-exempt entity in the deemed short year ending on 
the day immediately preceding the date of the listing; and
    (2) Beginning on the date of the listing (and accordingly subject to 
tax under section 4965(a)) to the extent such income or proceeds would 
have been properly taken into account in accordance with this section by 
the tax-exempt entity in the short year beginning on the date of the 
listing.
    (f) Examples. The following examples illustrate the allocation rules 
of this section:

    Example 1. (i) In 1999, X, a calendar year non-plan entity using the 
cash method of accounting, entered into a lease-in/lease-out transaction 
(LILO) substantially similar to the transaction described in Notice 
2000-15 (2000-1 CB 826) (describing Rev. Rul. 99-14 (1999-1 CB 835), 
superseded by Rev. Rul. 2002-69 (2002-2 CB 760)). In 1999, X purported 
to lease property to Y pursuant to a ``head lease,'' and Y purported to 
lease the property back to X pursuant to a ``sublease'' of a shorter 
term. In form, X received $268M as an advance payment of head lease 
rent. Of this amount, $200M had been, in form, financed by a nonrecourse 
loan obtained by Y. X deposited the $200M with a ``debt payment 
undertaker.'' This served to defease both a portion of X's rent 
obligation under its sublease and Y's repayment obligation under the 
nonrecourse loan. Of the remainder of the $268M advance head lease rent 
payment, X deposited $54M with an ``equity payment undertaker.'' This 
served to defease the remainder of X's rent obligation under the 
sublease as well as the exercise price of X's end-of-sublease term 
purchase option. This amount inures to the benefit of Y and enables Y to 
recover its investment in the transaction and a return on that 
investment. In substance, the $54M is a loan from Y to X. X retained the 
remaining $14M of the advance head lease rent payment. In substance, 
this represents a fee for X's participation in the transaction. See 
Sec. 601.601(d)(2)(ii)(b) of this chapter.
    (ii) According to the substance of the transaction, the head lease, 
sublease and nonrecourse debt will be ignored for Federal income tax 
purposes. Therefore, any net income or proceeds resulting from these 
elements of the transaction will not be considered net income or 
proceeds attributable to the LILO transaction for purposes of section 
4965(a). The $54M deemed loan from Y to X and the $14M fee are not 
ignored for Federal income tax purposes.
    (iii) Under X's established cash basis method of accounting, any net 
income received in 1999 and attributable to the LILO transaction is 
allocated to X's December 31, 1999, tax year for purposes of section 
4965. The $14M fee received in 1999, which constitutes proceeds of the 
transaction, is likewise allocated to that tax year. Because the 1999 
tax year is before the effective date of the section 4965 tax, X will 
not be subject to any excise tax under section 4965 for the amounts 
received in 1999.
    (iv) Any earnings on the amount deposited with the equity payment 
undertaker that constitute gross income to X will be reduced by X's 
original issue discount deductions with respect to the deemed loan from 
Y, in determining X's net income from the transaction.
    Example 2. B, a non-plan entity using the cash method of accounting, 
has an annual accounting period that ends on December 31, 2006. B 
entered into a prohibited tax shelter transaction on March 15, 2006. On 
that date, B received a payment of $600,000 as a fee for its involvement 
in the transaction. B received no other proceeds or income attributable 
to this transaction in 2006. Under B's method of accounting, the payment 
received by B on March 15, 2006, is taken into account in the deemed 
short year ending on August 15, 2006. Accordingly, solely for purposes 
of section 4965, the payment is treated as allocable solely to the 
period ending on or before August 15, 2006, and is not subject to the 
excise tax imposed by section 4965(a).

[[Page 260]]

    Example 3. The facts are the same as in Example 2, except that B 
received an additional payment of $400,000 on September 30, 2006. Under 
B's method of accounting, the payment received by B on September 30, 
2006, is taken into account in the deemed short year beginning on August 
16, 2006. Accordingly, solely for purposes of section 4965, the $400,000 
payment is treated as allocable to the period beginning after August 15, 
2006, and is subject to the excise tax imposed by section 4965(a).
    Example 4. C, a non-plan entity using the cash method of accounting, 
has an annual accounting period that ends on December 31. C entered into 
a prohibited tax shelter transaction on May 1, 2005. On March 15, 2007, 
C received a payment of $580,000 attributable to the transaction. On 
June 1, 2007, the transaction is identified by the IRS in published 
guidance as a listed transaction. On June 15, 2007, C received an 
additional payment of $400,000 attributable to the transaction. Under 
C's method of accounting, the payments received on March 15, 2007, and 
June 15, 2007, are taken into account in 2007. The IRS will treat the 
period beginning on January 1, 2007, and ending on May 31, 2007, and the 
period beginning on June 1, 2007, and ending on December 31, 2007, as 
short taxable years. The payment received by C on March 15, 2007, is 
taken into account in the deemed short year ending on May 31, 2007. 
Accordingly, solely for purposes of section 4965, the payment is treated 
as allocable solely to the pre-listing period, and is not subject to the 
excise tax imposed by section 4965(a). The payment received by C on June 
15, 2007, is taken into account in the deemed short year beginning on 
June 1, 2007. Accordingly, solely for purposes of section 4965, the 
payment is treated as allocable to the post-listing period, and is 
subject to the excise tax imposed by section 4965(a).

    (g) Effective/applicability dates. See Sec. 53.4965-9 for the 
discussion of the relevant effective and applicability dates.

[T.D. 9492, 75 FR 38702, July 6, 2010; 75 FR 46844, Aug. 4, 2010]



Sec. 53.4965-9  Effective/applicability dates.

    (a) In general. The taxes under section 4965(a) and Sec. 53.4965-7 
are effective for taxable years ending after May 17, 2006, with respect 
to transactions entered into before, on or after that date, except that 
no tax under section 4965(a) applies with respect to income or proceeds 
that are properly allocable to any period ending on or before August 15, 
2006.
    (b) Applicability of the regulations. As of July 6, 2010, except as 
provided in paragraph (c) of this section, Sec. Sec. 53.4965-1 through 
53.4965-8 of this chapter will apply to taxable years ending after July 
6, 2007. A tax-exempt entity may rely on the provisions of Sec. Sec. 
53.4965-1 through 53.4965-8 for taxable years ending on or before July 
6, 2007.
    (c) Effective/applicability date with respect to certain knowing 
transactions--(1) Entity-level tax. The 100 percent tax under section 
4965(b)(1)(B) and Sec. 53.4965-7(a)(1)(i)(B) does not apply to 
prohibited tax shelter transactions entered into by a tax-exempt entity 
on or before May 17, 2006.
    (2) Manager-level tax. The IRS will not assert that an entity 
manager who approved or caused a tax-exempt entity to become a party to 
a prohibited tax shelter transaction is liable for the entity manager 
tax under section 4965(b)(2) and Sec. 53.4965-7(b)(1) with respect to 
the transaction if the tax-exempt entity entered into such transaction 
prior to May 17, 2006.

[T.D. 9492, 75 FR 38702, July 6, 2010]



                 Subpart L_Procedure and Administration

    Source: T.D. 7368, 40 FR 29843, July 16, 1975, unless otherwise 
noted. Redesignated by T.D. 8084, 51 FR 16303, May 2, 1986.



Sec. 53.6001-1  Notice or regulations requiring records, statements, and
special returns.

    (a) In general. Any person subject to tax under Chapter 42, Subtitle 
D, of the Code shall keep such complete and detailed records as are 
sufficient to enable the district director to determine accurately the 
amount of liability under Chapter 42.
    (b) Notice by district director requiring returns, statements, or 
the keeping of records. The district director may require any person, by 
notice served upon him, to make such returns, render such statements, or 
keep such specific records as will enable the district director to 
determine whether or not such person is liable for tax under Chapter 42.
    (c) Retention of records. The records required by this section shall 
be kept at all times available for inspection by

[[Page 261]]

authorized internal revenue officers or employees, and shall be retained 
so long as the contents thereof may become material in the 
administration of any internal revenue law.



Sec. 53.6011-1  General requirement of return, statement or list.

    (a) Every private foundation liable for tax under section 4940 or 
4948(a) shall file an annual return with respect to such tax on the form 
prescribed by the Internal Revenue Service for such purpose and shall 
include therein the information required by such form and the 
instructions issued with respect thereto.
    (b) Every person liable for tax imposed by sections 4941(a), 
4942(a), 4943(a), 4944(a), 4945(a), 4955(a), 4958(a), or 4965(a), and 
every private foundation and every trust described in section 4947(a)(2) 
which has engaged in an act of self-dealing (as defined in section 
4941(d)) (other than an act giving rise to no tax under section 4941(a)) 
shall file an annual return on Form 4720 and shall include therein the 
information required by such form and the instructions issued with 
respect thereto. In the case of any tax imposed by sections 4941(a), 
4942(a), 4943(a), and 4944(a), the annual return shall be filed with 
respect to each act (or failure to act) for each year (or part thereof) 
in the taxable period (as defined in sections 4941 (e)(1), 4942(j)(1), 
4943(d)(2), and 4944(e)(1)). In the case of a tax imposed by section 
4945(a), 4955(a), 4958(a), or 4965(a), the annual return shall be filed 
with respect to each act for the year in which such act giving rise to 
liability occurred.
    (c) If a Form 4720 is filed by a private foundation or trust 
described in section 4947(a)(2) with respect to a transaction to which 
other persons are required to file under paragraph (b) of this section, 
such persons may by their signature designate such organization's Form 
4720 (to the extent applicable) as their return for purposes of 
compliance with such paragraph. However, this paragraph shall not apply 
to a person whose taxable year is other than the taxable year of the 
foundation or trust.
    (d) For taxable years ending on or after December 31, 1975, every 
trust described in section 4947(a)(2) which is subject to any of the 
provisions of Chapter 42 as if it were a private foundation shall file 
an annual return on Form 5227. For taxable years beginning after 
December 31, 1980, every trust described in section 4947(a)(1) which is 
a private foundation shall file an annual return on Form 990-PF.
    (e) For taxable years beginning after December 31, 1977, every 
person liable for tax under section 4951, 4952, or 4953 (relating to 
taxes on self-dealing, taxable expenditures, and excess contributions 
involving black lung benefit trusts) shall file an annual return with 
respect to the tax on the form prescribed by the Internal Revenue 
Service for that purpose. The person liable for the tax shall include 
the information required by the form and its related instructions.

[T.D. 7368, 40 FR 29843, July 16, 1975, as amended by T.D. 7838, 47 FR 
44249, Oct. 7, 1982; T.D. 8026, 50 FR 20757, May 20, 1985; T.D. 8628, 60 
FR 62212, Dec. 5, 1995; T.D. 8705, 62 FR 26, Jan. 2, 1997; T.D. 9334, 72 
FR 36872, July 6, 2007]



Sec. 53.6011-4  Requirement of statement disclosing participation in 
certain transactions by taxpayers.

    (a) In general. If a transaction is identified as a listed 
transaction or a transaction of interest as defined in Sec. 1.6011-4 of 
this chapter by the Commissioner in published guidance (see Sec. 
601.601(d)(2)(ii)(b) of this chapter), and the listed transaction or 
transaction of interest involves an excise tax under chapter 42 of 
subtitle D of the Internal Revenue Code (relating to private foundations 
and certain other tax-exempt organizations), the transaction must be 
disclosed in the manner stated in such published guidance.
    (b) Effective/applicability date. This section applies to listed 
transactions entered into on or after January 1, 2003. This section 
applies to transactions of interest entered into on or after November 2, 
2006.

[T.D. 9350, 72 FR 43154, Aug. 3, 2007]



Sec. 53.6060-1  Reporting requirements for tax return preparers.

    (a) In general. A person that employs one or more tax return 
preparers to prepare a return or claim for refund of tax under Chapter 
42 of the Internal

[[Page 262]]

Revenue Code, other than for the person, at any time during a return 
period, shall satisfy the record keeping and inspection requirements in 
the manner stated in Sec. 1.6060-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78457, Dec. 22, 2008]



Sec. 53.6061-1  Signing of returns and other documents.

    Any return, statement, or other document required to be made with 
respect to a tax imposed by Chapter 42 or the regulations thereunder 
shall be signed by the person required to file such return, statement or 
document, or by such other persons required or duly authorized to sign 
in accordance with the regulations, forms or instructions prescribed 
with respect to such return, statement or other document. The person 
required or duly authorized to make the return may incur liability for 
penalties provided for erroneous, false or fraudulent returns. For 
criminal penalties see sections 7201, 7203, 7206, and 7207.



Sec. 53.6065-1  Verification of returns.

    (a) Penalties of perjury. If a return, statement, or other document 
made under the provisions of Chapter 42 or Subtitle F of the Code or the 
regulations thereunder with respect to any tax imposed by Chapter 42 of 
the Code, or the form and instructions issued with respect to such 
return, statement, or other document, requires that it shall contain or 
be verified by a written declaration that it is made under the penalties 
of perjury, it must be so verified by the person or persons required to 
sign such return, statement, or other document. In addition, any other 
statement or document submitted under any provision of Chapter 42 or 
Subtitle F of the Code or regulations thereunder with respect to any tax 
imposed by Chapter 42 of the Code may be required to contain or be 
verified by a written declaration that it is made under the penalties of 
perjury.
    (b) Oath. Any return, statement, or other document required to be 
submitted under Chapter 42 or Subtitle F of the Code or regulations 
prescribed thereunder with respect to any tax imposed by Chapter 42 of 
the Code may be required to be verified by an oath.



Sec. 53.6071-1  Time for filing returns.

    (a) General rule. Except as otherwise provided in this section, a 
return required by Sec. 53.6011-1 shall be filed at the time the 
private foundation or trust described in section 4947(a)(2) is required 
to file its annual information or tax return under section 6033 or 6012 
(as may be applicable).
    (b) Exception. The Form 4720 of a person whose taxable year ends on 
a date other than that on which the taxable year of the foundation or 
trust ends shall be filed on or before the 15th day of the fifth month 
following the close of such person's taxable year.
    (c) Form 5227. A Form 5227 required to be filed by paragraph (d) of 
Sec. 53.6011-1 for a trust described in section 4947(a) shall be filed 
on or before the 15th day of the fourth month following the close of the 
trust's taxable year.
    (d) Taxes related to black lung benefit trusts. Forms 990-BL and 
6069 shall be filed on or before the 15th day of the fifth month 
following the close of the filer's taxable year.
    (e) Taxes related to political expenditures of organizations 
described in section 501(c)(3) of the Internal Revenue Code. A Form 4720 
required to be filed by Sec. 53.6011-1(b) for an organization liable 
for tax imposed by section 4955(a) must be filed by the unextended due 
date for filing its annual information return under section 6033 or, if 
the organization is exempt from filing, the date the organization would 
be required to file an annual information return if it was not exempt 
from filing. The Form 4720 of a person whose taxable year ends on a date 
other than that on which the taxable year of the organization described 
in section 501(c)(3) ends must be filed on or before the 15th day of the 
fifth month following the close of the person's taxable year.
    (f) Taxes imposed on excess benefit transactions engaged in by 
organizations described in sections 501(c)(3) (except private 
foundations) and 501(c)(4)--(1) General rule. A Form 4720 required by 
Sec. 53.6011-1(b) for a disqualified person or

[[Page 263]]

organization manager liable for tax imposed by section 4958(a) shall be 
filed by that person on or before the 15th day of the fifth month 
following the close of such person's taxable year.
    (2) Special rule for taxable years ending after September 13, 1995, 
and on or before July 30, 1996. A Form 4720 required by Sec. 53.6011-
1(b) for a disqualified person or organization manager liable for tax 
imposed by section 4958(a) on an excess benefit transaction occurring in 
such person's taxable year ending after September 13, 1995, and on or 
before July 30, 1996, is due on or before December 15, 1996.
    (g) Taxes imposed with respect to prohibited tax shelter 
transactions to which tax-exempt entities are parties--(1) Returns by 
certain tax-exempt entities. A Form 4720, ``Return of Certain Excise 
Taxes Under Chapters 41 and 42 of the Internal Revenue Code,'' required 
by Sec. 53.6011-1(b) for a tax-exempt entity described in section 
4965(c)(1), (c)(2) or (c)(3) that is a party to a prohibited tax shelter 
transaction and is liable for tax imposed by section 4965(a)(1) shall be 
filed on or before the due date (not including extensions) for filing 
the tax-exempt entity's annual information return under section 
6033(a)(1). If the tax-exempt entity is not required to file an annual 
information return under section 6033(a)(1), the Form 4720 shall be 
filed on or before the 15th day of the fifth month after the end of the 
tax-exempt entity's taxable year or, if the entity has not established a 
taxable year for Federal income tax purposes, the entity's annual 
accounting period.
    (2) Returns by entity managers of tax-exempt entities described in 
section 4965(c)(1), (c)(2) or (c)(3). A Form 4720, required by Sec. 
53.6011-1(b) for an entity manager of a tax-exempt entity described in 
section 4965(c)(1), (c)(2) or (c)(3) who is liable for tax imposed by 
section 4965(a)(2) shall be filed on or before the 15th day of the fifth 
month following the close of the entity manager's taxable year during 
which the entity entered into the prohibited tax shelter transaction.
    (3) Transition rule. A Form 4720, for a section 4965 tax that was 
due on or before October 4, 2007, will be deemed to have been filed on 
the due date if it was filed by October 4, 2007, and if all section 4965 
taxes required to be reported on that Form 4720 were paid by October 4, 
2007.
    (h) Effective/applicability date. Paragraph (g) of this section is 
applicable on July 6, 2007.

[T.D. 7368, 40 FR 29843, July 16, 1975, as amended by T.D. 7407, 41 FR 
9322, Mar. 4, 1976; T.D. 7838, 47 FR 44249, Oct. 7, 1982; T.D. 8628, 60 
FR 62212, Dec. 5, 1995; T.D. 8736, 62 FR 52257, Oct. 7, 1997; T.D. 9334, 
72 FR 36872, July 6, 2007; T.D. 9492, 75 FR 38708, July 6, 2010; 75 FR 
46845, Aug. 4, 2010]



Sec. 53.6071-1T  Time for filing returns (temporary).

    (a) through (f) [Reserved] For further guidance, see Sec. 53.6071-
1(a) through (f).

[T.D. 9334, 72 FR 36872, July 6, 2007; 72 FR 45895, Aug. 16, 2007, as 
amended by T.D. 9492, 75 FR 38708, July 6, 2010]



Sec. 53.6081-1  Automatic extension of time for filing the return to
report taxes due under section 4951 for self-dealing with a nuclear 

decommissioning fund.

    (a) In general. A ``disqualified person'' for purposes of section 
4951(e)(4) who engaged in self-dealing with a Nuclear Decommissioning 
Fund, and must report tax due under section 4951 on Form 1120-ND, 
``Return for Nuclear Decommissioning Funds and Certain Related 
Persons,'' will be allowed an automatic 6-month extension of time to 
file the return after the date prescribed for filing the return if the 
disqualified person files an application under this section in 
accordance with paragraph (b) of this section. For guidance on 
requesting an extension of time to file Form 1120-ND for purposes of 
reporting contributions received, income earned, administrative expenses 
of operating the fund, and the tax on modified gross income, see Sec. 
1.6081-3 of this chapter.
    (b) Requirements. To satisfy this paragraph (b), a disqualified 
person must--
    (1) Submit a complete application on Form 7004, ``Application for 
Automatic Extension of Time to File Certain Business Income Tax, 
Information, and Other Returns,'' or in any other manner prescribed by 
the Commissioner;
    (2) File the application on or before the date prescribed for filing 
the return

[[Page 264]]

with the Internal Revenue Service office designated in the application's 
instructions; and
    (3) Remit the amount of the properly estimated unpaid tax liability 
on or before the date prescribed for payment.
    (c) No extension of time for the payment of tax. An automatic 
extension of time for filing a return granted under paragraph (a) of 
this section will not extend the time for payment of any tax due on such 
return.
    (d) Termination of automatic extension. The Commissioner may 
terminate an automatic extension at any time by mailing to the 
disqualified person a notice of termination at least 10 days prior to 
the termination date designated in such notice. The Commissioner must 
mail the notice of termination to the address shown on the Form 7004 or 
to the disqualified person's last known address. For further guidance 
regarding the definition of last known address, see Sec. 301.6212-2 of 
this chapter.
    (e) Penalties. See section 6651 for failure to file or failure to 
pay the amount shown as tax on the return.
    (f) Effective/applicability dates. This section is applicable for 
applications for an automatic extension of time to file a return to 
report taxes due under section 4951 for self-dealing with a Nuclear 
Decommissioning Fund filed after July 1, 2008.

[T.D. 9407, 73 FR 37369, July 1, 2008]



Sec. 53.6091-1  Place for filing chapter 42 tax returns.

    Except as provided in Sec. 53.6091-2 (relating to exceptional 
cases):
    (a) Persons other than corporations. Chapter 42 tax returns of 
persons other than corporations shall be filed with any person assigned 
the responsibility to receive returns in the local Internal Revenue 
Service office that serves the legal residence or principal place of 
business of the person required to make the return.
    (b) Corporations. Chapter 42 tax returns of corporations shall be 
filed with any person assigned the responsibility to receive returns in 
the local Internal Revenue Service office that serves the principal 
place of business or principal office or agency of the corporation.
    (c) Returns filed with service centers. Notwithstanding paragraphs 
(a) and (b) of this section, unless a return is filed by hand carrying, 
whenever instructions applicable to Chapter 42 tax returns provide that 
the returns be filed with a service center, the returns must be so filed 
in accordance with the instructions. Returns which are filed by hand 
carrying shall be filed with any person assigned the responsibility to 
receive hand-carried returns in the local Internal Revenue Service 
office in accordance with paragraphs (a) or (b) of this section, 
whichever is applicable.
    (d) Returns of persons subject to a termination assessment. 
Notwithstanding paragraph (c) of this section, income tax returns of 
persons with respect to whom a chapter 42 tax assessment was made under 
section 6852(a) with respect to the taxable year must be filed with any 
person assigned the responsibility to receive returns in the local 
Internal Revenue Service office as provided in paragraphs (a) and (b) of 
this section.

[T.D. 7368, 40 FR 29843, July 16, 1975, as amended by T.D. 7495, 42 FR 
33727, July 1, 1977; T.D. 8628, 60 FR 62212, Dec. 5, 1995; T.D. 9156, 69 
FR 55746, Sept. 16, 2004]



Sec. 53.6091-2  Exceptional cases.

    Notwithstanding the provisions of Sec. 53.6091-1, the Commissioner 
may permit the filing of any Chapter 42 tax return in any local Internal 
Revenue Service office.

[T.D. 7368, 40 FR 29843, July 16, 1975. Redesignated by T.D. 8084, 51 FR 
16303, May 2, 1986, as amended by T.D. 9156, 69 FR 55746, Sept. 16, 
2004]



Sec. 53.6107-1  Tax return preparer must furnish copy of return or claim
for refund to taxpayer and must retain a copy or record.

    (a) In general. A person who is a signing tax return preparer of any 
return or claim for refund of tax under Chapter 42 of the Internal 
Revenue Code shall furnish a completed copy of the return or claim for 
refund to the taxpayer and retain a completed copy or record in the 
manner stated in Sec. 1.6107-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and

[[Page 265]]

claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78457, Dec. 22, 2008]



Sec. 53.6109-1  Tax return preparers furnishing identifying numbers for
returns or claims for refund filed.

    (a) In general. Each tax return or claim for refund under Chapter 42 
of the Internal Revenue Code prepared by one or more signing tax return 
preparers must include the identifying number of the preparer required 
by Sec. 1.6695-1(b) of this chapter to sign the return or claim for 
refund in the manner stated in Sec. 1.6109-2 of this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed after December 31, 
2008.

[T.D. 9436, 73 FR 78457, Dec. 22, 2008]



Sec. 53.6151-1  Time and place for paying tax shown on returns.

    The Chapter 42 tax shown on any return shall, without assessment or 
notice and demand, be paid to the internal revenue officer with whom the 
return is filed at the time and place for filing such return (determined 
without regard to any extension of time for filing the return). For 
provisions relating to the time and place for filing such return, see 
Sec. Sec. 53.6071-1 and 53.6091-1. For provisions relating to the 
extension of time for paying the tax, see Sec. 53.6161-1.



Sec. 53.6161-1  Extension of time for paying tax or deficiency.

    (a) In general--(1) Tax shown or required to be shown on return. A 
reasonable extension of the time for payment of the amount of any tax 
imposed by Chapter 42 and shown or required to be shown on any return, 
may be granted by the district directors and directors of the service 
centers at the request of the taxpayer. The period of such extension 
shall not be in excess of 6 months from the date fixed for payment of 
such tax, except that if the taxpayer is abroad the period of the 
extension may be in excess of 6 months.
    (2) Deficiency. The time for payment of any amount determined as a 
deficiency in respect of tax imposed by Chapter 42 may, at the request 
of the taxpayer, be extended by the internal revenue officer to whom the 
tax is required to be paid for a period not to exceed 18 months from the 
date fixed for payment of the deficiency, as shown on the notice and 
demand, and, in exceptional cases for a further period not in excess of 
12 months. No extension of the time for payment of a deficiency shall be 
granted if the deficiency is due to negligence, to intentional disregard 
of rules and regulations, or to fraud with intent to evade tax.
    (3) Extension of time for filing distinguished. The granting of an 
extension of time for filing a return does not operate to extend the 
time for the payment of the tax or any part thereof unless so specified 
in the extension.
    (b) Undue hardship required for extension. An extension of the time 
for payment shall be granted only upon a satisfactory showing that 
payment on the due date of the amount with respect to which the 
extension is desired will result in an undue hardship. The extension 
will not be granted upon a general statement of hardship. The term 
``undue hardship'' means more than an inconvenience to the taxpayer. It 
must appear that substantial financial loss, for example, loss due to 
the sale of property at a sacrifice price, will result to the taxpayer 
from making payment on the due date of the amount with respect to which 
the extension is desired. If a market exists, the sale of property at 
the current market price is not ordinarily considered as resulting in an 
undue hardship.
    (c) Application for extension. An application for an extension of 
the time for payment of the tax shown or required to be shown on any 
return, or for the payment of any amount determined as a deficiency 
shall be made on Form 1127 and shall be accompanied by evidence showing 
the undue hardship that would result to the taxpayer if the extension 
were refused. Such application shall also be accompanied by a statement 
of the assets and liabilities of the taxpayer and an itemized statement 
showing all receipts and disbursements for each of the three months 
immediately preceding the due date of the amount to which the 
application relates. The application, with supporting documents, must be 
filed on or before the date prescribed for payment of the

[[Page 266]]

amount with respect to which the extension is desired with the internal 
revenue officer to whom the tax is to be paid. The application will be 
examined, and within 30 days, if possible, will be denied, granted, or 
tentatively granted subject to certain conditions of which the taxpayer 
will be notified. If an additional extension is desired, the request 
therefor must be made on or before the expiration of the period for 
which the prior extension is granted.
    (d) Payment pursuant to extension. If an extension of time for 
payment is granted, the amount the time for payment of which is so 
extended shall be paid on or before the expiration of the period of the 
extension without the necessity of notice and demand. The granting of an 
extension of the time for payment of the tax or deficiency does not 
relieve the taxpayer from liability for the payment of interest thereon 
during the period of the extension. See section 6601 and Sec. 301.6601-
1 of this chapter (Regulations on Procedure and Administration).



Sec. 53.6165-1  Bonds where time to pay tax or deficiency has been 
extended.

    If an extension of time for payment of tax or deficiency is granted 
under section 6161, the district director or the director of the service 
center may, if he deems it necessary, require a bond for the payment of 
the amount in respect of which the extension is granted in accordance 
with the terms of the extension. However, such bond shall not exceed 
double the amount with respect to which the extension is granted. For 
provisions relating to form of bonds, see the regulations under section 
7101 contained in part 301 of this chapter (Regulations on Procedure and 
Administration).



Sec. 53.6601-1  Interest on underpayment, nonpayment, or extensions of
time for payment, of tax.

    For regulations concerning interest on underpayment, nonpayment, or 
extensions of time for payment of tax, see Sec. 301.6601-1 of this 
chapter (Regulations on Procedure and Administration).



Sec. 53.6651-1  Failure to file tax return or to pay tax.

    (a) General rules. For general rules relating to the failure to file 
tax return or to pay tax, see the regulations under section 6651 
contained in part 301 of this chapter (Regulations on Procedure and 
Administration).
    (b) Special rule where foundation files return. (1) Except as 
provided in paragraph (b)(2) of this section, in the case of tax imposed 
by section 4941(a)(1) on any disqualified person, reasonable cause shall 
be presumed, for purposes of section 6651(a)(1), where the private 
foundation or trust described in section 4947(a)(2) files a return in 
good faith and such return indicates no tax liability with respect to 
such tax on the part of such disqualified person.
    (2) Paragraph (b)(1) of this section shall not apply where the 
disqualified person knew of facts which, if known by the foundation, 
would have precluded the foundation from making the return, as filed, in 
good faith.



Sec. 53.6694-1  Section 6694 penalties applicable to tax return preparer.

    (a) In general. For general definitions regarding section 6694 
penalties applicable to preparers of tax returns or claims for refund 
under Chapter 42 of the Internal Revenue Code, see Sec. 1.6694-1 of 
this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed, and advice provided, 
after December 31, 2008.

[T.D. 9436, 73 FR 78457, Dec. 22, 2008]



Sec. 53.6694-2  Penalties for understatement due to an unreasonable 
position.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under Chapter 42 of the Internal Revenue Code 
(Code) shall be subject to penalties under section 6694(a) of the Code 
in the manner stated in Sec. 1.6694-2 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78457, Dec. 22, 2008]

[[Page 267]]



Sec. 53.6694-3  Penalty for understatement due to willful, reckless, or
intentional conduct.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under Chapter 42 of the Internal Revenue Code 
(Code) shall be subject to penalties under section 6694(b) of the Code 
in the manner stated in Sec. 1.6694-3 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78457, Dec. 22, 2008]



Sec. 53.6694-4  Extension of period of collection when tax return 
preparer pays 15 percent of a penalty for understatement of taxpayer's 

liability and certain other procedural matters.

    (a) In general. For rules relating to the extension of period of 
collection when a tax return preparer who prepared a return or claim for 
refund of tax under Chapter 42 of the Internal Revenue Code pays 15 
percent of a penalty for understatement of taxpayer's liability and 
procedural matters relating to the investigation, assessment and 
collection of the penalties under section 6694(a) and (b), the rules 
under Sec. 1.6694-4 of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78458, Dec. 22, 2008]



Sec. 53.6695-1  Other assessable penalties with respect to the 
preparation of tax returns or claims for refund for other persons.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under Chapter 42 of the Internal Revenue Code 
(Code) shall be subject to penalties for failure to furnish a copy to 
the taxpayer under section 6695(a) of the Code, failure to sign the 
return under section 6695(b) of the Code, failure to furnish an 
identification number under section 6695(c) of the Code, failure to 
retain a copy or list under section 6695(d) of the Code, failure to file 
a correct information return under section 6695(e) of the Code, and 
negotiation of a check under section 6695(f) of the Code, in the manner 
stated in Sec. 1.6695-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78458, Dec. 22, 2008]



Sec. 53.6696-1  Claims for credit or refund by tax return preparers.

    (a) In general. For rules for claims for credit or refund by a tax 
return preparer who prepared a return or claim for refund for tax under 
Chapter 42 of the Internal Revenue Code, the rules under Sec. 1.6696-1 
of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78458, Dec. 22, 2008]



Sec. 53.7101-1  Form of bonds.

    For provisions relating to form of bonds, see the regulations under 
section 7101 contained in part 301 of this chapter (Regulations on 
Procedure and Administration).



Sec. 53.7701-1  Tax return preparer.

    (a) In general. For the definition of a tax return preparer, see 
Sec. 301.7701-15 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78458, Dec. 22, 2008]



PART 54_PENSION EXCISE TAXES--Table of Contents



Sec.
54.4971-1 General rules relating to excise tax on failure to meet 
          minimum funding standards.
54.4972-1 Tax on excess contributions to plans benefiting self-employed 
          individuals.
54.4974-1 Excise tax on accumulations in individual retirement accounts 
          or annuities.
54.4974-2 Excise tax on accumulations in qualified retirement plans.
54.4975-1 General rules relating to excise tax on prohibited 
          transactions.
54.4975-6 Statutory exemptions for office space or services and certain 
          transactions involving financial institutions.

[[Page 268]]

54.4975-7 Other statutory exemptions.
54.4975-9 Definition of ``fiduciary''.
54.4975-11 ``ESOP'' requirements.
54.4975-12 Definition of the term ``qualifying employer security''.
54.4975-14 Election to pay an excise tax for certain pre-1975 prohibited 
          transactions.
54.4975-15 Other transitional rules.
54.4976-1T Questions and answers relating to taxes with respect to 
          welfare benefit funds (temporary).
54.4977-1T Questions and answers relating to the election concerning 
          lines of business in existence on January 1, 1984 (temporary).
54.4978-1T Questions and answers relating to the tax on certain 
          dispositions by employee stock ownership plans and certain 
          cooperatives (temporary).
54.4979-0 Excise tax on certain excess contributions and excess 
          aggregate contributions; table of contents.
54.4979-1 Excise tax on certain excess contributions and excess 
          aggregate contributions.
54.4980B-0 Table of contents.
54.4980B-1 CORBA in general.
54.4980B-2 Plans that must comply.
54.4980B-3 Qualified beneficiaries.
54.4980B-4 Qualifying events.
54.4980B-5 CORBA continuation coverage.
54.4980B-6 Electing COBRA continuation coverage.
54.4980B-7 Duration of CORBA continuation coverage.
54.4980B-8 Paying for COBRA continuation coverage.
54.4980B-9 Business reorganizations and employer withdrawals from 
          multiemployer plans.
54.4980B-10 Interaction of FMLA and COBRA.
54.4980D-1 Requirement of return and time for filing of the excise tax 
          under section 4980D.
54.4980E-1 Requirement of return and time for filing of the excise tax 
          under section 4980E.
54.4980F-1 Notice requirements for certain pension plan amendments 
          significantly reducing the rate of future benefit accrual.
54.4980G-0 Table of contents.
54.4980G-1 Failure of employer to make comparable health savings account 
          contributions.
54.4980G-2 Employer contribution defined.
54.4980G-3 Failure of employer to make comparable health savings account 
          contributions.
54.4980G-4 Calculating comparable contributions.
54.4980G-5 HSA comparability rules and cafeteria plans and waiver of 
          excise tax.
54.4980G-6 Special rule for contributions made to the HSAs of nonhighly 
          compensated employees.
54.4980G-7 Special comparability rules for qualified HSA distributions 
          contributed to HSAs on or after December 20, 2006 and before 
          January 1, 2012.
54.4981A-1T Tax on excess distributions and excess accumulations 
          (temporary).
54.6011-1 General requirement of return, statement, or list.
54.6011-1T General requirement of return, statement, or list 
          (temporary).
54.6011-2 General requirement of return, statement, or list.
54.6011-4 Requirement of statement disclosing participation in certain 
          transactions by taxpayers.
54.6060-1 Reporting requirements for tax return preparers.
54.6061-1 Signing of returns and other documents.
54.6071-1 Time for filing returns.
54.6081-1 Automatic extension of time for filing returns for certain 
          excise taxes under Chapter 43.
54.6091-1 Place for filing excise tax returns under section 4980B, 
          4980D, 4980E, or 4980G.
54.6107-1 Tax return preparer must furnish copy of return or claims for 
          refund to taxpayer and must retain a copy or record.
54.6109-1 Tax return preparers furnishing identifying numbers for 
          returns or claims for refund filed.
54.6151-1 Time and place for paying of tax shown on returns.
54.6694-1 Section 6694 penalties applicable to tax return preparer.
54.6694-2 Penalties for understatement due to an unreasonable position.
54.6694-3 Penalty for understatement due to willful, reckless, or 
          intentional conduct.
54.6694-4 Extension of period of collection when tax return preparer 
          pays 15 percent of a penalty for understatement of taxpayer's 
          liability and certain other procedural matters.
54.6695-1 Other assessable penalties with respect to the preparation of 
          tax returns for other persons.
54.6696-1 Claims for credit or refund by tax return preparers.
54.7701-1 Tax return preparer.
54.9801-1 Basis and scope.
54.9801-2 Definitions.
54.9801-3 Limitations on preexisting condition exclusion period.
54.9801-4 Rules relating to creditable coverage.
54.9801-5 Evidence of creditable coverage.
54.9801-6 Special enrollment periods.
54.9802-1 Prohibiting discrimination against participants and 
          beneficiaries based on a health factor.
54.9802-2 Special rules for certain church plans.

[[Page 269]]

54.9802-3T Additional requirements prohibiting discrimination based on 
          genetic information (temporary).
54.9811-1 Standards relating to benefits for mothers and newborns.
54.9812-1T Parity in mental health and substance use disorder benefits 
          (temporary).
54.9815-1251T Preservation of right to maintain existing coverage 
          (temporary).
54.9815-2704T Prohibition of preexisting condition exclusions 
          (temporary).
54.9815-2711T No lifetime or annual limits (temporary).
54.9815-2712T Rules regarding rescissions (temporary).
54.9815-2713 Coverage of preventive health services.
54.9815-2713T Coverage of preventive health services (temporary).
54.9815-2714T Eligibility of children until at least age 26 (temporary).
54.9815-2715 Summary of benefits and coverage and uniform glossary.
54.9815-2719AT Patient protections (temporary).
54.9815-2719T Internal claims and appeals and external review processes 
          (temporary).
54.9831-1 Special rules relating to group health plans.
54.9833-1 Effective dates.

    Authority: 26 U.S.C. 7805, unless otherwise noted.
    Section 54.4974-2 also issued under 26 U.S.C. 4974;
    Section 54.4981A-1T also issued under 26 U.S.C. 4981A;
    Section 54.4980B-1 also issued under 26 U.S.C. 4980B;
    Section 54.4980B-2 also issued under 26 U.S.C. 4980B;
    Section 54.4980B-3 also issued under 26 U.S.C. 4980B;
    Section 54.4980B-4 also issued under 26 U.S.C. 4980B;
    Section 54.4980B-5 also issued under 26 U.S.C. 4980B;
    Section 54.4980B-6 also issued under 26 U.S.C. 4980B;
    Section 54.4980B-7 also issued under 26 U.S.C. 4980B;
    Section 54.4980B-8 also issued under 26 U.S.C. 4980B;
    Section 54.4980B-9 also issued under 26 U.S.C. 4980B;
    Section 54.4980B-10 also issued under 26 U.S.C. 4980B;
    Section 54.4980F-1 also issued under 26 U.S.C. 4980F;
    Section 54.4980G-1 also issued under 26 U.S.C. 4980G;
    Section 54.4980G-2 also issued under 26 U.S.C. 4980G;
    Section 54.4980G-3 also issued under 26 U.S.C. 4980G;
    Section 54.4980G-4 also issued under 26 U.S.C. 4980G;
    Section 54.4980G-5 also issued under 26 U.S.C. 4980G;
    Section 54.4980G-6 also issued under 26 U.S.C. 4980G;
    Section 54.4980G-7 also issued under 26 U.S.C. 4980G;
    Section 54.6060-1 also issued under 26 U.S.C. 6060(a);
    Section 54.6081-1 also issued under 26 U.S.C. 6081(a);
    Section 54.6109-1 also issued under 26 U.S.C. 6109(a);
    Section 54.6109-2 also issued under 26 U.S.C. 6109(a);
    Section 54.6695-1 also issued under 26 U.S.C. 6695(b);
    Section 54.9801-1 also issued under 26 U.S.C. 9833;
    Section 54.9801-2 also issued under 26 U.S.C. 9833;
    Section 54.9801-3 also issued under 26 U.S.C. 9801(c)(4), 
9801(e)(3), and 9833;
    Section 54.9801-4 also issued under 26 U.S.C. 9801(c)(1)(I) and 
9833;
    Section 54.9801-5 also issued under 26 U.S.C. 9801(c)(4), 
9801(e)(3); and 9833.
    Section 54.9801-6 also issued under 26 U.S.C. 9833;
    Section 54.9802-1 also issued under 26 U.S.C. 9833;
    Section 54.9802-2 also issued under 26 U.S.C. 9833;
    Section 54.9802-3T also issued under 26 U.S.C. 9833;
    Section 54.9811-1 also issued under 26 U.S.C. 9833;
    Section 54.9812-1T also issued under 26 U.S.C. 9833;
    Section 54.9815-1251T also issued under 26 U.S.C. 9833;
    Section 54.9815-2704T also issued under 26 U.S.C. 9833;
    Section 54.9815-2711T also issued under 26 U.S.C. 9833;
    Section 54.9815-2712T also issued under 26 U.S.C. 9833;
    Section 54.9815-2713T also issued under 26 U.S.C. 9833;
    Section 54.9815-2714T also issued under 26 U.S.C. 9833;
    Section 54.9815-2719AT also issued under 26 U.S.C. 9833;
    Section 54.9815-2719T also issued under 26 U.S.C. 9833;
    Section 54.9831-1 also issued under 26 U.S.C. 9833;
    Section 54.9833-1 also issued under 26 U.S.C. 9833.

    Effective Date Note: By T.D. 9575, 77 FR 8697, Feb. 14, 2012, and by 
T.D. 9578, 77 FR 8729, Feb. 15, 2012, the authority citation for part 54 
was ammended by adding entries for Sec. 54.9815-2715 and Sec. 54.9815-
2713 in numerical order, effective Apr. 16, 2012. For the convenience of 
the user, the added text is set forth as follows:

[[Page 270]]



  

    Authority: 26 U.S.C. 7805. * * *

                                * * * * *

    Section 54.9815-2713 also issued under 26 U.S.C. 9833.

                                * * * * *

    Section 54.9815-2715 also issued under 26 U.S.C. 9833.

                                * * * * *



Sec. 54.4971-1  General rules relating to excise tax on failure to meet
minimum funding standards.

    (a)-(b) [Reserved]
    (c) Additional tax. Section 4971(b) imposes an excise tax in any 
case in which an initial tax is imposed under section 4971(a) on an 
accumulated funding deficiency and the accumulated funding deficiency is 
not corrected within the taxable period (as defined in section 
4971(c)(3)). The additional tax is 100 percent of the accumulated 
funding deficiency to the extent not corrected.
    (d) [Reserved]
    (e) Definition of taxable period--(1) In general. For purposes of 
any accumulated funding deficiency, the term ``taxable period'' means 
the period beginning with the end of the plan year in which there is an 
accumulated funding deficiency and ending on the earlier of:
    (i) The date of mailing of a notice of deficiency under section 6212 
with respect to the tax imposed by section 4971(a), or
    (ii) The date on which the tax imposed by section 4971(a) is 
assessed.
    (2) Special rule. Where a notice of deficiency referred to in 
paragraph (e)(1)(i) of this section is not mailed because a waiver of 
the restrictions on assessment and collection of a deficiency has been 
accepted or because the deficiency is paid, the date of filing of the 
waiver or the date of such payment, respectively, shall be treated as 
the end of the taxable period.

[T.D. 8084, 51 FR 16305, May 2, 1986]



Sec. 54.4972-1  Tax on excess contributions to plans benefiting 
self-employed individuals.

    (a) In general. Section 4972 imposes a tax of 6 percent on the 
amount of the excess contributions (as defined in section 4972 (b) and 
(c) of this section) under certain qualified plans (as defined in 
paragraph (b) of this section) for each taxable year beginning after 
December 31, 1975, of the employer who maintains such plan. Partnerships 
and sole proprietors are to report this tax by filing Form 5330 (or 
other designated form) and the tax is to be paid annually at the time 
prescribed for filing such return (determined without regard to any 
extension of time for filing).
    (b) Employers to whom section applies. The tax under section 4972 is 
imposed on employers who maintain a qualified plan during their taxable 
year. For this purpose, the term qualified plan means a pension or 
profit-sharing plan which includes a trust described in section 401(a), 
an annuity plan described in section 403(a), or a bond purchase plan 
described in section 405(a). In addition to being a qualified plan, the 
plan must provide contributions or benefits for employees some or all of 
whom are employees within the meaning of section 401(c)(1). For this 
purpose, the plan does not have to provide contributions or benefits for 
employees who are employees within the meaning of section 401(c)(1) 
during the taxable year; it is sufficient that the plan so provided in a 
prior taxable year.
    (c) Excess contributions--(1) In general. For a taxable year of an 
employer for purposes of section 4972 and this section, the term 
``excess contributions'' means:
    (i) The amount (if any) by which the sum of:
    (A) The amount (if any) determined under section 4972(b)(2) and 
paragraph (d) of this section, plus
    (B) The amount (if any) determined under section 4972(b)(3) and 
paragraph (e) of this section, plus
    (C) The amount (if any) determined under section 4972(b)(4) and 
paragraph (f) of this section, exceeds
    (ii) The amount (if any) of any correcting distributions (as defined 
in section 4972(b)(5) and paragraph (g) of this

[[Page 271]]

section) made in all prior taxable years beginning after December 31, 
1975.
    (2) Contributions allocable to insurance. For purposes of section 
4972(b) and this section, the amount of any contribution made under the 
plan which is allocable to the purchase of life, accident, health, or 
other insurance is not taken into account. The amount of any 
contribution which is allocable to the cost of insurance protection is 
determined in accordance with the provisions of paragraph (g) of Sec. 
1.404(e)-1A and paragraph (b) of Sec. 1.72-16.
    (d) Contributions by owner-employees--(1) General rule. In the case 
of a plan which provides contributions or benefits for employees some or 
all of whom are owner-employees, within the meaning of section 
401(c)(3), the amount determined under section 4972(b)(2) and this 
paragraph for the employer's taxable year is the amount computed 
separately with respect to each owner-employee equal to the sum of:
    (i) The excess (if any) of
    (A) The amount contributed under the plan by each owner-employee as 
an employee (that is, each owner-employee's contributions within the 
meaning of section 401(c)(5)(B)) for such taxable year of the employer, 
over
    (B) The amount permitted under section 4972(c) and paragraph (h) of 
this section to be contributed by each owner-employee as an employee for 
such taxable year of the employer, and
    (ii) The amount determined under section 4972(b)(2) and this 
paragraph for the immediately preceding taxable year of the employer, 
reduced by the excess (if any) of the amount described in subdivision 
(1)(B) of this subparagraph over the amount described in subdivision 
(1)(A) of this subparagraph for such taxable year of the employer.
    (2) Rollover amounts. The provisions of section 4972 (c) and 
paragraph (d) of this section are not applicable to amounts contributed 
on behalf of an owner-employee in a rollover contribution described in 
section 402(a)(5), 403(a)(4), 408(d)(3), or 409(b)(3)(C).
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. (i) A and B are the only owner-employees covered under 
the X Employees' Trust. The X Partnership, the X Trust, and the X Plan 
all use the calendar year as their annual accounting period, at all 
relevant times. The amount determined under section 4972(b)(2) for 1975 
is 0 because this section does not apply to contributions made for 
taxable years beginning before January 1, 1976. In calendar year 1976, A 
contributes $2,500 and B contributes $2,500 to the trust. The amount 
permitted to be contributed to the trust for 1976 with respect to A as 
an employee is $1,800 and with respect to B as an employee is $2,200.
    (ii) The amount determined under this paragraph for 1976 with 
respect to A is $700, computed as follows: the sum of the excess of the 
amount contributed by A ($2,500) over the amount permitted to be 
contributed by A ($1,800), and the amount determined under this 
paragraph for A in 1975 (0).
    (iii) The amount determined under this paragraph for 1976 with 
respect to B is $300, computed as follows: the sum of the excess of the 
amount contributed by B ($2,500) over the amount permitted to be 
contributed by B ($2,200), and the amount determined under this 
paragraph for B in 1975 (0).
    (iv) The amount determined under section 4972(b)(2) and this 
paragraph for 1976 with respect to the employer, X Partnership, is 
$1,000, the sum of the amounts determined separately under this 
paragraph with respect to A ($700) and B ($300). The tax under section 
4972 for 1976 on the X Partnership (assuming that no other events 
affecting the determination of the tax under section 4972 occur) is 6 
percent of $1,000 or $60.
    Example 2. (i) Assume the facts stated in Example (1). In calendar 
year 1977, A contributes $1,500 and B contributes $2,300 to the trust. 
Assume that the amount permitted to be contributed to the trust for 
1977, under section 4972(c) for A and B is $2,500 each.
    (ii) The amount determined under this paragraph for 1977 with 
respect to A is 0, computed as follows: the sum of 0 (the excess of the 
amount contributed by A ($1,500) over the amount permitted to be 
contributed ($2,500)) and $700, the amount determined under this 
paragraph for A in 1976, reduced by $1,000 (the amount permitted to be 
contributed by A ($2,500) over the amount contributed by A ($1,500)).
    (iii) The amount determined under this paragraph for 1977 with 
respect to B is $100, computed as follows: the sum of 0 (the excess of 
the amount contributed by B ($2,300) over the amount permitted to be 
contributed ($2,500)) and $300, the amount determined under this 
paragraph for B in 1976, reduced by $200 (the amount permitted to be 
contributed ($2,500) by B over the amount contributed by B ($2,300)).
    (iv) The amount determined under section 4972(b) and this paragraph 
for 1977 with respect to the employer, X Partnership, is $100, the sum 
of the amounts determined separately under this paragraph with respect 
to

[[Page 272]]

A ($0) and B ($100). The tax imposed under section 4972 for 1977 on the 
X Partnership (assuming that no other events affecting the determination 
of the tax under section 4972 occur) is 6 percent of $100, or $6.

    (e) Defined benefit plans--(1) General rule. In the case of a 
defined benefit plan (as defined in section 414(j)), the amount 
determined under section 4972(b)(3) and this paragraph for the taxable 
year of the employer is the amount contributed under the plan by the 
employer during the taxable year plus the amounts, if any, contributed 
by the employer during any prior taxable year beginning after December 
31, 1975, if:
    (i) As of the close of the taxable year, the full funding limitation 
of the plan (determined under section 412(c)(7) and the regulations 
thereunder) is zero, and
    (ii) Such amounts contributed have not been deductible by the 
employer for the taxable year or for any prior taxable year beginning 
after December 31, 1975.


See section 404 and the regulations thereunder for the determination of 
the amount deductible by the employer for the taxable year. If the 
amounts contributed by the employer exceed the amounts which have been 
deductible, the amount determined under this paragraph shall not exceed 
the amounts which have not been deductible. For purposes of this 
paragraph, the determination of both the amounts contributed and the 
amounts deductible by the employer for any relevant taxable year 
includes amounts contributed and deductible on behalf of any employee 
covered under the plan, including common-law employees and other self-
employed individuals who are not owner-employees in addition to owner-
employees. The determination of whether the full funding limitation is 
zero shall be made taking into account all the plan assets unreduced by 
any deduction carryover under section 404(a)(1)(D). The determination of 
whether the full funding limitation is zero as of the close of the 
employer's taxable year shall be made with respect to the plan year 
ending with or within the employer's taxable year. Consequently, if an 
employer whose taxable year is the calendar year establishes and 
maintains a defined benefit plan whose plan year begins on July 1 and 
ends on June 30, the full funding limitation for that plan will be 
determined with respect to the plan year ending on June 30 within the 
calendar taxable year including that June 30.
    (2) Illustration. The provisions of this paragraph may be 
illustrated by the following example:

    Example. (i) X Partnership (``X'') adopts the Y Defined Benefit Plan 
(``Y Plan'') on January 1, 1977. The taxable year of X is the calendar 
year. The Y Plan also has a calendar plan year. For 1977, $25,000 is 
contributed to the Y Plan by X. Assume that for 1977, (1) only $10,000 
is deductible by X for 1977 under section 404 and (2) the full funding 
limitation of the Y Plan (determined under section 412(c)(7)) on 
December 31, 1977, is greater than zero. For 1978, X makes no additional 
contributions to the Y Plan. Assume that for 1978, (1) no amount is 
deductible by X under section 404 and (2) the full funding limitation of 
the Y Plan (determined under section 412(c)(7)) on December 31, 1978, is 
zero. The amount determined under section 4972(b)(3) and this paragraph 
for the 1978 taxable year is $15,000, computed as follows: the 
difference between (A) the sum of the amounts contributed by X for 
taxable year 1978 (0), and the amounts contributed by X for taxable year 
1977 ($25,000) and (B) the sum of the amount deductible for taxable year 
1978 (0) and the amount deductible for taxable year 1977 ($10,000). The 
tax imposed under section 4972 for 1978 on X (assuming that no other 
events affecting the determination of the tax under section 4972 occur) 
is 6 percent of $15,000 or $900.
    (ii) For 1979, X makes no additional contributions to the Y Plan. 
Assume that for 1979, (1) the full funding limitation of the Y Plan 
determined under section 412(c)(7) is greater than zero. Assume further 
that $10,000 of the amounts contributed for 1977 is deductible by X for 
1979 under section 404. There is no amount determined under section 
4972(b)(3) and this paragraph for 1979 because the condition described 
in subparagraph (1)(i) of this paragraph is not satisfied.
    (iii) For 1980, X makes no additional contributions to the Y Plan. 
Assume that for 1980, (1) no amount is deductible under section 404 and 
(2) the full funding limitation of the Y Plan (determined under section 
412(c)(7)) on December 31, 1980, is zero. The amount determined under 
section 4972(b)(3) and this paragraph for the 1980 taxable year is 
$5,000, computed as follows: the difference between (A) $25,000, the sum 
of the amounts contributed by X for taxable years 1980 (0), 1979 (0), 
1978 (0), and 1977 ($25,000) and (B) $20,000, the sum of the amounts 
deductible for taxable years 1980 (0), 1979 ($10,000), 1978 (0), and 
1977 ($10,000). The tax imposed under

[[Page 273]]

section 4972 for 1980 on X (assuming that no other events affecting the 
determination of the tax under section 4972 occur) is 6 percent of 
$5,000, or $300.

    (f) Defined contribution plans--(1) General rule. In the case of a 
defined contribution plan (as defined in section 414(i)), the amount 
determined under section 4972(b)(4) and this paragraph for the taxable 
year of the employer is equal to the portion of the amounts contributed 
under the plan by the employer during the taxable year plus the amounts 
contributed by the employer during any prior taxable year beginning 
after December 31, 1975, which has not been deductible by the employer 
for the taxable year or for any such prior taxable year. For purposes of 
this paragraph, the determination of both the amounts contributed and 
the amounts deductible by the employer for any relevant taxable year 
includes amounts contributed and deductible on behalf of any employee 
covered under the plan, including common-law employees and other self-
employed individuals who are not owner-employees in addition to owner-
employees.
    (2) Illustration. The provisions of this paragraph may be 
illustrated by the following example:

    Example. (i) The X Partnership (``X'') adopts the Z Defined 
Contribution Plan and Trust (``Z Plan'') on January 1, 1976. X's taxable 
year and the plan year of Z Plan are both calendar years. For 1976, X 
contributes $40,000, of which $30,000 is deductible under section 404 
for taxable year 1976. The amount determined under section 4972(b)(4) 
and this paragraph for 1976 is $10,000 (the difference between (A) 
$40,000, the amount contributed by X for taxable year 1976 and (B) 
$30,000, the amount deductible for taxable year 1976).
    (ii) For 1977, X contributes $25,000, and the amounts deductible by 
X under section 404 for taxable year 1977 is $30,000 ($5,000 for the 
contribution carryover from 1976 and $25,000 with respect to the 1977 
contribution). The amount determined under section 4972(b)(4) and this 
paragraph for 1977 is $5,000, computed as follows: the difference 
between (A) $65,000, the sum of the amounts contributed by X for taxable 
year 1976 ($40,000) and the amounts contributed by X for taxable year 
1977 ($25,000), and (B) $60,000, the sum of the amounts deductible for 
taxable year 1976 ($30,000) and the amounts deductible for taxable year 
1977 ($30,000).

    (g) Correcting distribution--(1) General rule. For purposes of 
section 4972(b) and this paragraph, the term ``correcting distribution'' 
means, for the taxable year of the employer, the sum of:
    (i) In the case of a contribution made as an employee by an owner-
employee, within the meaning of section 401(c)(3), to a defined benefit 
or defined contribution plan, the amount, or any part thereof, 
determined under section 4972(b)(2) and paragraph (d) of this section 
which is distributed to the owner-employee who contributed such amount 
to the plan;
    (ii) In the case of a defined benefit plan, the amount, or any part 
thereof, determined under section 4972(b)(3) and paragraph (e) of this 
section which is distributed from the plan to the employer, and
    (iii) In the case of a defined contribution plan, the amount, or any 
part thereof, determined under section 4972(b)(4) and paragraph (f) of 
this section which is distributed to (A) the employer or (B) to the 
employee for whom such amount was contributed.

If, for any employer taxable year in which a defined contribution plan 
is maintained, there is a correcting distribution to an employee which 
could be from amounts described in subparagraph (1)(i) and (iii) of this 
paragraph for such employee, then such correcting distribution shall be 
deemed to be made first from amounts described in such subparagraph 
(1)(i) and then from amounts described in such subparagraph (1)(iii) for 
purposes of this section and section 72. For the income tax treatment of 
such distributions to employees, see section 72 and the regulations 
thereunder. Any such distributions to employees shall not be subject to 
the tax imposed by section 4975 nor result in the defined contribution 
plan failing to satisfy the exclusive benefit requirement of section 
401(a), solely by reason of being a correcting distribution within the 
meaning of this paragraph. If, for any employer taxable year in which a 
defined benefit, or defined contribution plan is maintained, there is a 
correcting distribution described in subparagraph (1)(ii) or (iii) of 
this paragraph to the employer maintaining the plan, such distribution 
shall not be subject to the tax imposed by section 4975 nor result in 
the plan's failing to satisfy the exclusive benefit

[[Page 274]]

or the definitely determinable requirements under section 401(a). If, 
for any employer taxable year in which a money purchase pension plan is 
maintained, a correcting distribution described in subparagraph (1)(iii) 
of this paragraph is made to an employee who has not yet become eligible 
to receive retirement benefits under the plan, the qualification of the 
pension plan (and trust) under section 401(a) may be adversely affected. 
See Sec. 1.401-1(b)(1)(i). A correcting distribution described in 
subparagraph (1)(iii) of this paragraph to an owner-employee prior to 
age 59\1/2\ must be precluded under the plan. See section 401(d)(4)(B).
    (2) Illustration. The provisions of this paragraph may be 
illustrated by the following example:

    Example. (i) A and B are owner-employees who are over the age of 
59\1/2\ and who are covered under the X Employees' Defined Contribution 
Plan and Profit-Sharing Trust (``Plan Y''). The X Partnership (``X'') 
and Plan Y are on calendar years. In calendar year 1976, A contributes 
$2,500 and B contributes $2,500 to Plan Y. The amount permitted to be 
contributed to Plan Y for 1976 with respect to A as an employee is 
$1,800 and with respect to B as an employee is $2,200. X contributes to 
Plan Y $5,000 on behalf of A and $5,000 on behalf of B. Of this amount, 
assume that $2,700 is deductible with respect to A and $3,300 is 
deductible with respect to B by X under section 404. The amount 
determined under section 4972(b)(2) and paragraph (d) of this section 
(the excess owner-employee contributions made by A and B to Plan Y) for 
taxable year 1976 is $1,000, computed as follows: the sum of (A) for A, 
$700, the difference between his own contributions ($2,500) and the 
amount permitted to be contributed by A ($1,800) and (B) for B, $300, 
the difference between his own contributions ($2,500) and the amount 
permitted to be contributed by B ($2,200). The amount determined under 
section 4972(b)(4) and paragraph (f) of this section (the excess 
contributions made by X to Plan Y) for taxable year 1976 is $4,000, 
computed as follows: the sum of (A) by X for A, $2,300, the difference 
between contributions by X ($5,000) and the amount deductible by X for A 
($2,700) and (B) by X for B, $1,700, the difference between 
contributions by X for B ($5,000) and the amount deductible by X for B 
($3,300). During 1976, there is no correcting distribution, within the 
meaning of section 4972 and this paragraph, because there are no 
distributions to A, B, or X.
    (ii) Assume that, for taxable year 1977, the amounts determined 
under sections 4972(b)(2) and 4972(b)(4) remain the same as for taxable 
year 1976, that is, $1,000 ($700 for A and $300 for B) and $4,000 
($2,300 by X for A and $1,700 by X for B), respectively. Assume further 
that, in 1977, Plan Y distributes $3,000 to A and $1,000 to B. The 
amount determined under section 4972(b)(5) and this paragraph (the 
correcting distribution for Plan Y) for taxable year 1977 is $4,000, 
computed and attributed as follows: the sum of (A) $3,000 with respect 
to A, the amount of the distribution to A applied first to A's $700 
amount described in subparagraph (1)(i) of this paragraph and next to 
A's $2,300 amount described in subparagraph (1)(iii) of this paragraph 
and (B) $1,000 with respect to B, the amount of the distribution to B 
applied first to B's $300 amount described in subparagraph (1)(i) of 
this paragraph and next to B's $1,700 amount described in subparagraph 
(1)(iii) of this paragraph. For purposes of computing the excess 
contributions for taxable year 1977, the correcting distribution of 
$4,000 would not be taken into account because only correcting 
distributions for prior year are considered. However, for taxable year 
1978 the correcting distribution of $4,000 would be taken into account.
    (iii) Assume that, for taxable year 1978, there are no additional 
amounts determined under sections 4972(b)(2) and 4972(b)(4) and that 
Plan Y distributes $900 to B. The amount determined under section 
4972(b)(5) and this paragraph (the correcting distribution for Plan Y) 
for the 1978 taxable year is $900, computed and attributed as follows: 
the amount of the distribution to B, $900, applied to B's $1,000 amount 
described in subparagraph (1)(iii) of this paragraph. For purposes of 
computing the excess contributions for taxable year 1978, the correcting 
distribution of $900 would not be taken into account. However, for 
taxable year 1979, the correcting distribution of $900 would be taken 
into account.

    (h) Amount permitted to be contributed by owner-employee--(1) 
General rule. Except as provided in subparagraph (2), for purposes of 
section 4972(b)(2) and paragraph (d), the amount permitted to be 
contributed under a plan by an owner-employee as an employee for any 
taxable year of the employer is the smallest of the following:
    (i) $2,500;
    (ii) 10 percent of the earned income (as defined in section 
401(c)(2)) for such taxable year derived by the owner-employee from the 
trade or business with respect to which the plan is established, or
    (iii) The amount of the contribution which would be contributed by 
the owner-employee (as an employee) if such contribution were made at 
the

[[Page 275]]

rate of contributions which is permitted to be made by employees who are 
not owner-employees during such taxable year.
    (2) Special rule. In the case of a taxable year of the employer in 
which there are no employees other than owner-employees, the amount 
permitted to be contributed under a plan by an owner-employee (as an 
employee) is zero.
    (i) Special rules and cross references--(1) Time of contributions. 
For purposes of this section, time of employer contributions made with 
respect to any taxable year shall take into account the rules specified 
in section 404(a)(6), relating to time when contributions deemed made.
    (2) Disallowance of deduction. For disallowance of deduction for 
taxes paid under this section, see section 275(a)(6).
    (3) Certain annuity contracts. For a special rule relating to owner-
employee contributions for premiums on annuity, etc. contracts, see 
Sec. 1.401(e)4(a)
    (4) Disqualification for excess contributions. For plan 
qualification requirements relating to excess contributions, see section 
401(d)(5).

[T.D. 7759, 46 FR 6932, Jan. 22, 1981]



Sec. 54.4974-1  Excise tax on accumulations in individual retirement 
accounts or annuities.

    (a) General rule. A tax equal to 50 percent of the amount by which 
the minimum amount required to be distributed from an individual 
retirement account or annuity described in section 408 during the 
taxable year of the payee under paragraph (b) of this section exceeds 
the amount actually distributed during the taxable year is imposed by 
section 4974 on the payee.
    (b) Minimum amount required to be distributed. For purposes of this 
section, the minimum amount required to be distributed is the amount 
required under Sec. 1.408-2(b)(6)(v) to be distributed in the taxable 
year described in paragraph (a) of this section.
    (c) Examples. The application of this section may be illustrated by 
the following examples.

    Example 1. In 1975, the minimum amount required to be distributed 
under Sec. 1.408-2(b)(6)(v) to A under his individual retirement 
account is $100. Only $60 is actually distributed to A in 1975. Under 
section 4974, A would have an excise tax liability of $20 [50% of ($100-
$60)].
    Example 2. Although no distribution is required under Sec. 1.408-
2(b)(6)(v) to be made in 1986, H, a married individual born on February 
1, 1921, who has established and maintained an individual retirement 
account decides to begin receiving distributions from the account 
beginning in 1986. H's wife, W, was born on March 6, 1921. H and W are 
calendar year taxpayers. H decides to receive his interest in the 
account over the joint life and last survivor expectancy of himself and 
his wife. On January 1, 1986, the balance in H's account is $10,000; H 
and W, based on their nearest birthdates, are 65; and the joint life and 
last survivor expectancy of H and his wife is 22.0 years (see Table II 
of Sec. 1.72-9). His annual payments during the following years (none 
of which were required) were determined by dividing the balance in the 
account on the first day of each year by the joint life and last 
survivor expectancy reduced by the number of whole years elapsed since 
the distributions were to commence.

------------------------------------------------------------------------
                                             Life      Account
                                          expectancy   balance
                                             minus        at      Annual
                  Date                       whole    beginning  payment
                                             years     of each
                                            elapsed      year
------------------------------------------------------------------------
Jan. 1, 1986............................      22.0      $10,000    $455
Jan. 1, 1987............................      21.0       10,118     482
Jan. 1, 1988............................      20.0       10,214     511
Jan. 1, 1989............................      19.0       10,285     541
Jan. 1, 1990............................      18.0       10,329     574
Jan. 1, 1991............................      17.0       10,340     608
------------------------------------------------------------------------


For 1986, 1987, 1989, and 1990, the amount required to be distributed 
under Sec. 1.408-2(b)(6)(v) is zero. Thus, H would have no excise tax 
liability under section 4974 for these years. In 1991, the year H 
attains age 70\1/2\, the amount required to be distributed from the 
account under Sec. 1.408-2(b)(6)(v) is $565, determined by dividing 
$10,340 (the account balance as of January 1, 1991) by 18.8 years (the 
joint life and last survivor expectancy of H and W, assuming they are 
both still living, as of January 1, 1991). If W should die after 
December 31, 1990, the joint life and last survivor expectancy 
determined on January 1, 1991 (18.3 years) would not be redetermined. 
Because the amount distributed from the account in 1991 ($608) exceeds 
the amount required to be distributed from the account in 1991 ($565), H 
has no excise tax liability under section 4974 for 1991.
    Example 3. Assume the same facts as in example (2) except that W 
dies in 1988. For 1988, 1989, and 1990, the amount required to be 
distributed under Sec. 1.408-2(b)(6)(v) is zero. Thus, H would have no 
excise tax liability under section 4974 for these years. In 1991, the 
amount required to be distributed under

[[Page 276]]

Sec. 1.408-2(b)(6)(v) is $855, determined by dividing $10,340 (the 
account balance as of January 1, 1991) by 12.1 years (the life 
expectancy of H as of January 1, 1991). Because the amount distributed 
from the account in 1991 ($608) is less than the amount required to be 
distributed from the account in 1991 ($855), H has an excise tax 
liability of $123.50 under section 4974 for 1991 [50% of ($855-$608)].

[T.D. 7714, 45 FR 52799, Aug. 8, 1980]



Sec. 54.4974-2  Excise tax on accumulations in qualified retirement plans.

    Q-1. Is any tax imposed on a payee under any qualified retirement 
plan or any eligible deferred compensation plan (as defined in section 
457(b)) to whom an amount is required to be distributed for a taxable 
year if the amount distributed during the taxable year is less than the 
required minimum distribution?
    A-1. Yes, if the amount distributed to a payee under any qualified 
retirement plan or any eligible deferred compensation plan (as defined 
in section 457(b)) for a calendar year is less than the required minimum 
distribution for such year, an excise tax is imposed on such payee under 
section 4974 for the taxable year beginning with or within the calendar 
year during which the amount is required to be distributed. The tax is 
equal to 50 percent of the amount by which such required minimum 
distribution exceeds the actual amount distributed during the calendar 
year. Section 4974 provides that this tax shall be paid by the payee. 
For purposes of section 4974, the term required minimum distribution 
means the minimum distribution amount required to be distributed 
pursuant to section 401(a)(9), 403(b)(10), 408(a)(6), 408(b)(3), or 
457(d)(2), as the case may be, and the regulations thereunder. Except as 
otherwise provided in A-6 of this section, the required minimum 
distribution for a calendar year is the required minimum distribution 
amount required to be distributed during the calendar year. A-6 of this 
section provides a special rule for amounts required to be distributed 
by an employee's (or individual's) required beginning date.

 Q-2. For purposes of section 4974, what is a qualified retirement plan?

    A-2. For purposes of section 4974, each of the following is a 
qualified retirement plan--
    (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) An annuity contract, custodial account, or retirement income 
account described in section 403(b);
    (d) An individual retirement account described in section 408(a) 
(including a Roth IRA described in section 408A);
    (e) An individual retirement annuity described in section 408(b) 
(including a Roth IRA described in section 408A); or
    (f) Any other plan, contract, account, or annuity that, at any time, 
has been treated as a plan, account, or annuity described in paragraphs 
(a) through (e) of this A-2, whether or not such plan, contract, 
account, or annuity currently satisfies the applicable requirements for 
such treatment.
    Q-3. If a payee's interest under a qualified retirement plan is in 
the form of an individual account, how is the required minimum 
distribution for a given calendar year determined for purposes of 
section 4974?
    A-3. (a) General rule. If a payee's interest under a qualified 
retirement plan is in the form of an individual account and distribution 
of such account is not being made under an annuity contract purchased in 
accordance with A-4 of Sec. 1.401(a)(9)-6, the amount of the required 
minimum distribution for any calendar year for purposes of section 4974 
is the required minimum distribution amount required to be distributed 
for such calendar year in order to satisfy the minimum distribution 
requirements in Sec. 1.401(a)(9)-5 as provided in the following 
(whichever is applicable)--
    (1) Section 401(a)(9) and Sec. Sec. 1.401(a)(9)-1 through 
1.401(a)(9)-5 and 1.401(a)(9)-7 through 1.401(a)(9)-9 in the case of a 
plan described in section 401(a) which includes a trust exempt under 
section 501(a) or an annuity plan described in section 403(a);
    (2) Section 403(b)(10) and Sec. 1.403(b)-6(e) (in the case of an 
annuity contract,

[[Page 277]]

custodial account, or retirement income account described in section 
403(b));
    (3) Section 408(a)(6) or (b)(3) and Sec. 1.408-8 (in the case of an 
individual retirement account or annuity described in section 408(a) or 
(b)); or
    (4) Section 457(d) in the case of an eligible deferred compensation 
plan (as defined in section 457(b)).
    (b) Default provisions. Unless otherwise provided under the 
qualified retirement plan (or, if applicable, the governing instrument 
of the qualified retirement plan), the default provisions in A-4(a) of 
Sec. 1.401(a)(9)-3 apply in determining the required minimum 
distribution for purposes of section 4974.
    (c) Five-year rule. If the 5-year rule in section 401(a)(9)(B)(ii) 
applies to the distribution to a payee, no amount is required to be 
distributed for any calendar year to satisfy the applicable enumerated 
section in paragraph (a) of this A-3 until the calendar year which 
contains the date 5 years after the date of the employee's death. For 
the calendar year which contains the date 5 years after the employee's 
death, the required minimum distribution amount required to be 
distributed to satisfy the applicable enumerated section is the payee's 
entire remaining interest in the qualified retirement plan.
    Q-4. If a payee's interest in a qualified retirement plan is being 
distributed in the form of an annuity, how is the amount of the required 
minimum distribution determined for purposes of section 4974?
    A-4. If a payee's interest in a qualified retirement plan is being 
distributed in the form of an annuity (either directly from the plan, in 
the case of a defined benefit plan, or under an annuity contract 
purchased from an insurance company), the amount of the required minimum 
distribution for purposes of section 4974 will be determined as follows:
    (a) Permissible annuity distribution option. A permissible annuity 
distribution option is an annuity contract (or, in the case of annuity 
distributions from a defined benefit plan, a distribution option) which 
specifically provides for distributions which, if made as provided, 
would for every calendar year equal or exceed the minimum distribution 
amount required to be distributed to satisfy the applicable section 
enumerated in paragraph (a) of A-2 of this section for every calendar 
year. If the annuity contract (or, in the case of annuity distributions 
from a defined benefit plan, a distribution option) under which 
distributions to the payee are being made is a permissible annuity 
distribution option, the required minimum distribution for a given 
calendar year will equal the amount which the annuity contract (or 
distribution option) provides is to be distributed for that calendar 
year.
    (b) Impermissible annuity distribution option. An impermissible 
annuity distribution option is an annuity contract (or, in the case of 
annuity distributions from a defined benefit plan, a distribution 
option) under which distributions to the payee are being made that 
specifically provides for distributions which, if made as provided, 
would for any calendar year be less than the minimum distribution amount 
required to be distributed to satisfy the applicable section enumerated 
in paragraph (a) of A-3 of this section. If the annuity contract (or, in 
the case of annuity distributions from a defined benefit plan, the 
distribution option) under which distributions to the payee are being 
made is an impermissible annuity distribution option, the required 
minimum distribution for each calendar year will be determined as 
follows:
    (1) If the qualified retirement plan under which distributions are 
being made is a defined benefit plan, the minimum distribution amount 
required to be distributed each year will be the amount which would have 
been distributed under the plan if the distribution option under which 
distributions to the payee were being made was the following permissible 
annuity distribution option:
    (i) In the case of distributions commencing before the death of the 
employee, if there is a designated beneficiary under the impermissible 
annuity distribution option for purposes of section 401(a)(9), the 
permissible annuity distribution option is the joint and survivor 
annuity option under the plan for the lives of the employee and the 
designated beneficiary that provides for the greatest level amount 
payable

[[Page 278]]

to the employee determined on an annual basis. If the plan does not 
provide such an option or there is no designated beneficiary under the 
impermissible distribution option for purposes of section 401(a)(9), the 
permissible annuity distribution option is the life annuity option under 
the plan payable for the life of the employee in level amounts with no 
survivor benefit.
    (ii) In the case of distributions commencing after the death of the 
employee, if there is a designated beneficiary under the impermissible 
annuity distribution option for purposes of section 401(a)(9), the 
permissible annuity distribution option is the life annuity option under 
the plan payable for the life of the designated beneficiary in level 
amounts. If there is no designated beneficiary, the 5-year rule in 
section 401(a)(9)(B)(ii) applies. See paragraph (b)(3) of this A-4. The 
determination of whether or not there is a designated beneficiary and 
the determination of which designated beneficiary's life is to be used 
in the case of multiple beneficiaries will be made in accordance with 
Sec. 1.401(a)(9)-4 and A-7 of Sec. 1.401(a)(9)-5. If the defined 
benefit plan does not provide for distribution in the form of the 
applicable permissible distribution option, the required minimum 
distribution for each calendar year will be an amount as determined by 
the Commissioner.
    (2) If the qualified retirement plan under which distributions are 
being made is a defined contribution plan and the impermissible annuity 
distribution option is an annuity contract purchased from an insurance 
company, the minimum distribution amount required to be distributed each 
year will be the amount that would have been distributed in the form of 
an annuity contract under the permissible annuity distribution option 
under the plan determined in accordance with paragraph (b)(1) of this A-
4 for defined benefit plans. If the defined contribution plan does not 
provide the applicable permissible annuity distribution option, the 
required minimum distribution for each calendar year will be the amount 
that would have been distributed under an annuity described in paragraph 
(b)(2)(i) or (ii) of this A-4 purchased with the employee's or 
individual's account used to purchase the annuity contract that is the 
impermissible annuity distribution option.
    (i) In the case of distributions commencing before the death of the 
employee, if there is a designated beneficiary under the impermissible 
annuity distribution option for purposes of section 401(a)(9), the 
annuity is a joint and survivor annuity for the lives of the employee 
and the designated beneficiary which provides level annual payments and 
which would have been a permissible annuity distribution option. 
However, the amount of the periodic payment which would have been 
payable to the survivor will be the applicable percentage under the 
table in A-2(c) of Sec. 1.401(a)(9)-6 of the amount of the periodic 
payment which would have been payable to the employee or individual. If 
there is no designated beneficiary under the impermissible distribution 
option for purposes of section 401(a)(9), the annuity is a life annuity 
for the life of the employee with no survivor benefit which provides 
level annual payments and which would have been a permissible annuity 
distribution option.
    (ii) In the case of a distribution commencing after the death of the 
employee, if there is a designated beneficiary under the impermissible 
annuity distribution option for purposes of section 401(a)(9), the 
annuity option is a life annuity for the life of the designated 
beneficiary which provides level annual payments and which would have 
been a permissible annuity distribution option. If there is no 
designated beneficiary, the 5-year rule in section 401(a)(9)(B)(ii) 
applies. See paragraph (b)(3) of this A-4. The amount of the payments 
under the annuity contract will be determined using the interest rate 
and actuarial tables prescribed under section 7520 determined using the 
date determined under A-3 of Sec. 1.401(a)(9)-3 when distributions are 
required to commence and using the age of the beneficiary as of the 
beneficiary's birthday in the calendar year that contains that date. The 
determination of whether or not there is a designated beneficiary and 
the determination of which designated beneficiary's life is to be used 
in the case of multiple beneficiaries will be

[[Page 279]]

made in accordance with Sec. 1.401(a)(9)-4 and A-7 of Sec. 
1.401(a)(9)-5.
    (3) If the 5-year rule in section 401(a)(9)(B)(ii) applies to the 
distribution to the payee under the contract (or distribution option), 
no amount is required to be distributed to satisfy the applicable 
enumerated section in paragraph (a) of this A-4 until the calendar year 
which contains the date 5 years after the date of the employee's death. 
For the calendar year which contains the date 5 years after the 
employee's death, the required minimum distribution amount required to 
be distributed to satisfy the applicable enumerated section is the 
payee's entire remaining interest in the annuity contract (or under the 
plan in the case of distributions from a defined benefit plan).
    (4) If the plan provides that the required beginning date for 
purposes of section 401(a)(9) for all employees is April 1 of the 
calendar year following the calendar year in which the employee attained 
age 70\1/2\ in accordance with paragraph A-2(e) of Sec. 1.401(a)(9)-2, 
the required minimum distribution for each calendar year for an employee 
who is not a 5-percent owner for purposes of this section will be the 
lesser of the amount determined based on the required beginning date as 
set forth in A-2(a) of Sec. 1.401(a)(9)-2 or the required beginning 
date under the plan. Thus, for example, if an employee dies after 
attaining age 70\1/2\, but before April 1 of the calendar year following 
the calendar year in which the employee retired, and there is no 
designated beneficiary as of September 30 of the year following the 
employee's year of death, required minimum distributions for calendar 
years after the calendar year containing the employee's date of death 
may be based on either the applicable distribution period provided under 
either the 5-year rule of A-1 of Sec. 1.401(a)(9)-3 or the employee's 
remaining life expectancy as set forth in A-5(c)(3) of Sec. 
1.401(a)(9)-5.
    Q-5. If there is any remaining benefit with respect to an employee 
(or IRA owner) after any calendar year in which the entire remaining 
benefit is required to be distributed under section 401(a)(9), what is 
the amount of the required minimum distribution for each calendar year 
subsequent to such calendar year?
    A-5. If there is any remaining benefit with respect to an employee 
(or IRA owner) after the calendar year in which the entire remaining 
benefit is required to be distributed, the required minimum distribution 
for each calendar year subsequent to such calendar year is the entire 
remaining benefit.
    Q-6. With respect to which calendar year is the excise tax under 
section 4974 imposed in the case in which the amount not distributed is 
an amount required to be distributed by April 1 of a calendar year (by 
the employee's or individual's required beginning date)?
    A-6. In the case in which the amount not paid is an amount required 
to be paid by April 1 of a calendar year, such amount is a required 
minimum distribution for the previous calendar year, i.e., for the 
employee's or the individual's first distribution calendar year. 
However, the excise tax under section 4974 is imposed for the calendar 
year containing the last day by which the amount is required to be 
distributed, i.e., the calendar year containing the employee's or 
individual's required beginning date, even though the preceding calendar 
year is the calendar year for which the amount is required to be 
distributed. There is also a required minimum distribution for the 
calendar year which contains the employee's or individual's required 
beginning date. Such distribution is also required to be made during the 
calendar year which contains the employee's or individual's required 
beginning date.
    Q-7. Are there any circumstances when the excise tax under section 
4974 for a taxable year may be waived?
    A-7. (a) Reasonable cause. The tax under section 4974(a) may be 
waived if the payee described in section 4974(a) establishes to the 
satisfaction of the Commissioner the following--
    (1) The shortfall described in section 4974(a) in the amount 
distributed in any taxable year was due to reasonable error; and
    (2) Reasonable steps are being taken to remedy the shortfall.
    (b) Automatic waiver. The tax under section 4974 will be 
automatically waived, unless the Commissioner determines otherwise, if--

[[Page 280]]

    (1) The payee described in section 4974(a) is an individual who is 
the sole beneficiary and whose required minimum distribution amount for 
a calendar year is determined under the life expectancy rule described 
in Sec. 1.401(a)(9)-3 A-3 in the case of an employee's or individual's 
death before the employee's or individual's required beginning date; and
    (2) The employee's or individual's entire benefit to which that 
beneficiary is entitled is distributed by the end of the fifth calendar 
year following the calendar year that contains the employee's or 
individual's date of death.

[T.D. 8987, 67 FR 19026, Apr. 17, 2002; 67 FR 35732, May 21, 2002, as 
amended by T.D. 9340, 72 FR 41160, July 26, 2007]



Sec. 54.4975-1  General rules relating to excise tax on prohibited 
transactions.

    (a) Scope. This section provides general rules for the imposition of 
the excise taxes on prohibited transactions.
    (b) Initial tax. Section 4975(a) imposes an initial tax on each 
prohibited transaction. The initial tax is 5 percent of the amount 
involved with respect to the prohibited transaction for each year (or 
part thereof) in the taxable period.
    (c) Additional tax. Section 4975(b) imposes an excise tax in any 
case in which an initial tax is imposed under section 4975(a) on a 
prohibited transaction and the prohibited transaction is not corrected 
within the taxable period (as defined in paragraph (d) of this section). 
The additional tax is 100 percent of the amount involved with respect to 
the prohibited transaction.
    (d) Taxable period--(1) In general. For purposes of any prohibited 
transaction, the term ``taxable period'' means the period beginning with 
the date on which the prohibited transaction occurs and ending on the 
earliest of:
    (i) The date of mailing of a notice of deficiency under section 6212 
with respect to the tax imposed by section 4975(a);
    (ii) The date on which correction of the prohibited transaction is 
completed; or
    (iii) The date on which the tax imposed by section 4975(a) is 
assessed.
    (2) Special rule. Where a notice of deficiency referred to in 
paragraph (d)(1)(i) of this section is not mailed because a waiver of 
the restrictions on assessment and collection of a deficiency has been 
accepted or because the deficiency is paid, the date of filing of the 
waiver or the date of such payment, respectively, shall be treated as 
the end of the taxable period.

[T.D. 8084, 51 FR 16305, May 2, 1986]



Sec. 54.4975-6  Statutory exemptions for office space or services and
certain transactions involving financial institutions.

    (a) Exemption for office space or services--(1) In general. Section 
4975(d)(2) exempts from the excise taxes imposed by section 4975 payment 
by a plan to a disqualified person, including a fiduciary, for office 
space or any service (or a combination of services), if (i) such office 
space or service is necessary for the establishment or operation of the 
plan; (ii) such office space or service is furnished under a contract or 
arrangement which is reasonable; and (iii) no more than reasonable 
compensation is paid for such office space or service. However, section 
4975(d)(2) does not contain an exemption for acts described in section 
4975(c)(1)(E) (relating to fiduciaries dealing with the income or assets 
of plans in their own interest or for their own account) or acts 
described in section 4975(c)(1)(F) (relating to fiduciaries receiving 
consideration for their own personal account from any party dealing with 
a plan in connection with a transaction involving the income or assets 
of the plan). Such acts are separate transactions not described in 
section 4975(d)(2). See Sec. Sec. 54.4975-6(a)(5) and 54.4975-6(a)(6) 
for guidance as to whether transactions relating to the furnishing of 
office space or services by fiduciaries to plans involve acts described 
in section 4975(c)(1)(E).

Section 4975(d)(2) does not contain an exemption from other provisions 
of the Code, such as section 401, or other provisions of law which may 
impose requirements or restrictions relating to the transactions which 
are exempt under section 4975(d)(2). See, for example, the general 
fiduciary responsibility provisions of section 404 of the

[[Page 281]]

Employee Retirement Income Security Act of 1974 (the Act) (88 Stat. 
877). The provisions of section 4975(d)(2) are further limited by the 
flush language at the end of section 4975(d) (relating to transactions 
with owner-employees and related persons).
    (2) Necessary service. A service is necessary for the establishment 
or operation of a plan within the meaning of section 4975(d)(2) and 
Sec. 54.4975-6(a)(1)(i) if the service is appropriate and helpful to 
the plan obtaining the service in carrying out the purposes for which 
the plan is established or maintained. A person providing such a service 
to a plan (or a person who is disqualified person solely by reason of a 
relationship to such a service provider described in section 4975(e)(2) 
(F), (G), (H), or (I)) may furnish goods which are necessary for the 
establishment or operation of the plan in the course of, and incidental 
to, the furnishing of such service to the plan.
    (3) Reasonable contract or arrangement. No contract or arrangement 
is reasonable within the meaning of section 4975(d)(2) and Sec. 
54.4975-6(a)(1)(ii) if it does not permit termination by the plan 
without penalty to the plan on reasonably short notice under the 
circumstances to prevent the plan from becoming locked into an 
arrangement that has become disadvantageous. A long-term lease which may 
be terminated prior to its expiration (without penalty to the plan) on 
reasonably short notice under the circumstances is not generally an 
unreasonable arrangement merely because of its long term. A provision in 
a contract or other arrangement which reasonably compensates the service 
provider or lessor for loss upon early termination of the contract, 
arrangement or lease is not a penalty. For example, a minimal fee in a 
service contract which is charged to allow recoupment of reasonable 
start-up costs is not a penalty.

Similarly, a provision in a lease for a termination fee that covers 
reasonably foreseeable expenses related to the vacancy and reletting of 
the office space upon early termination of the lease is not a penalty. 
Such a provision does not reasonably compensate for loss if it provides 
for payments in excess of actual loss or if it fails to require 
mitigation of damages.
    (4) Reasonable compensation. Section 4975(d)(2) and Sec. 54.4975-
6(a)(1)(iii) permit a plan to pay a disqualified person reasonable 
compensation for the provision of office space or services described in 
section 4975(d)(2). Paragraph (e) of this section contains regulations 
relating to what constitutes reasonable compensation for the provision 
of services.
    (5) Transactions with fiduciaries--(i) In general. If the furnishing 
of office space or a service involves an act described in section 
4975(c)(1) (E) or (F) (relating to acts involving conficts of interest 
by fiduciaries), such an act constitutes a separate transaction which is 
not exempt under section 4975(d)(2). The prohibitions of sections 
4975(c)(1) (E) and (F) supplement the other prohibitions of section 
4975(c)(1) by imposing on disqualified persons who are fiduciaries a 
duty of undivided loyalty to the plans for which they act. These 
prohibitions are imposed upon fiduciaries to deter them from exercising 
the authority, control, or responsibility which makes such persons 
fiduciaries when they have interests which may conflict with the 
interests of the plans for which they act. In such cases, the 
fiduciaries have interests in the transactions which may affect the 
exercise of their best judgment as fiduciaries. Thus, a fiduciary may 
not use the authority, control, or responsibility which makes such 
person a fiduciary to cause a plan to pay an additional fee to such 
fiduciary (or to a person in which such fiduciary has an interest which 
may affect the exercise of such fiduciary's best judgment as a 
fiduciary) to provide a service. Nor may a fiduciary use such authority, 
control, or responsibility to cause a plan to enter into a transaction 
involving plan assets whereby such fiduciary (or a person in which such 
fiduciary has an interest which may affect the exercise of such 
fiduciary's best judgment as a fiduciary) will receive consideration 
from a third party in connection with such transaction.

A person in which a fiduciary has an interest which may affect the 
exercise of such fiduciary's best judgment as a

[[Page 282]]

fiduciary includes, for example, a person who is a disqualified person 
by reason of a relationship to such fiduciary described in section 
4975(e)(2) (E), (F), (G), (H), or (I).
    (ii) Transactions not described in section 4975(c)(1)(E). A 
fiduciary does not engage in an act described in section 4975(c)(1)(E) 
if the fiduciary does not use any of the authority, control or 
responsibility which makes such person a fiduciary to cause a plan to 
pay additional fees for a service furnished by such fiduciary or to pay 
a fee for a service furnished by a person in which such fiduciary has an 
interest which may affect the exercise of such fiduciary's best judgment 
as a fiduciary. This may occur, for example, when one fiduciary is 
retained on behalf of a plan by a second fiduciary to provide a service 
for an additional fee. However, because the authority, control or 
responsibility which makes a person a fiduciary may be exercised ``in 
effect'' as well as in form, mere approval of the transaction by a 
second fiduciary does not mean that the first fiduciary has not used any 
of the authority, control or responsibility which makes such person a 
fiduciary to cause the plan to pay the first fiduciary an additional fee 
for a service.
    (iii) Services without compensation. If a fiduciary provides 
services to a plan without the receipt of compensation or other 
consideration (other than reimbursement of direct expenses properly and 
actually incurred in the performance of such services within the meaning 
of paragraph (e)(4) of this section), the provision of such services 
does not, in and of itself, constitute an act described in section 
4975(c)(1) (E) or (F). The allowance of a deduction to an employer under 
section 162 or 212 for the expense incurred in furnishing office space 
or services to a plan established or maintained by such employer does 
not constitute compensation or other consideration.
    (6) Examples. The provisions of Sec. 54.4975-6(a)(5) may be 
illustrated by the following examples:

    Example 1. E, an employer whose employees are covered by plan P, is 
a fiduciary or P. I is a professional investment adviser in which E has 
no interest which may affect the exercise of E's best judgment as a 
fiduciary. E causes P to retain I to provide certain kinds of investment 
advisory services of a type which causes I to be a fiduciary of P under 
section 4975(e)(3)(B). Thereafter, I proposes to perform for additional 
fees portfolio evaluation services in addition to the services currently 
provided. The provision of such services is arranged by I and approved 
on behalf of the plan by E. I has not engaged in an act described in 
section 4975(c)(1)(E), because I did not use any of the authority, 
control or responsibility which makes I a fiduciary (the provision of 
investment advisory services) to cause the plan to pay I additional fees 
for the provision of the portfolio evaluation services. E has not 
engaged in an act which is described in section 4975(c)(1)(E). E, as the 
fiduciary who has the responsibility to be prudent in his selection and 
retention of I and the other investments advisers of the plan, has an 
interest in the purchase by the plan of portfolio evaluation services. 
However, such an interest is not an interest which may affect the 
exercise of E's best judgment as a fiduciary.
    Example 2. D, a trustee of plan P with discretion over the 
management and disposition of plan assets, relies on the advice of C, a 
consultant to P, as to the investment of plan assets, thereby making C a 
fiduciary of the plan. On January 1, 1978, C recommends to D that the 
plan purchase an insurance policy from U, an insurance company which is 
not a disqualified person with respect to P. C thoroughly explains the 
reasons for the recommendation and makes a full disclosure concerning 
the fact that C will receive a commission from U upon the purchase of 
the policy by P. D considers the recommendation and approves the 
purchase of the policy by P. C receives a commission. Under such 
circumstances, C has engaged in an act described in section 
4975(c)(1)(E) (as well as section 4975(c)(1)(F), because C is in fact 
exercising the authority, control or responsibility which makes C a 
fiduciary to cause the plan to purchase the policy. However, the 
transaction is exempt from the prohibited transaction provisions of 
section 4975(c)(1) if the requirements of Prohibited Transaction 
Exemption 77-9 are met.
    Example 3. Assume the same facts as in Example (2) except that the 
nature of C's relationship with the plan is not such that C is a 
fiduciary of P. The purchase of the insurance policy does not involve an 
act described in section 4975(c)(1) (E) or (F), because such sections 
only apply to acts by fiduciaries.
    Example 4. E, an employer whose employees are covered by plan P, is 
a fiduciary with respect to P. A, who is not a disqualified person with 
respect to P, persuades E that the plan needs the services of a 
professional investment adviser and that A should be hired

[[Page 283]]

to provide the investment advice. Accordingly, E causes P to hire A to 
provide investment advice of the type which makes A a fiduciary under 
Sec. 54.4975-9(c)(1)(ii)(B). Prior to the expiration of A's first 
contract with P, A persuades E to cause P to renew A's contract with P 
to provide the same services for additional fees in view of the 
increased costs in providing such services. During the period of A's 
second contract, A provides additional investment advice services for 
which no additional charge is made. Prior to the expiration of A's 
second contract, A persuades E to cause P to renew his contract for 
additional fees in view of the additional services A is providing. A has 
not engaged in an act described in section 4975(c)(1)(E), because A has 
not used any of the authority, control or responsibility which makes A a 
fiduciary (the provision of investment advice) to cause the plan to pay 
additional fees for A's services.
    Example 5. F, a trustee of plan P with discretion over the 
management and disposition of plan assets, retains C to provide 
administrative services to P of the type which makes C a fiduciary under 
section 4975(e)(3)(C). Thereafter, C retains F to provide, for 
additional fees, actuarial and various kinds of administrative services 
in addition to the services F is currently providing to P. Both F and C 
have engaged in an act described in section 4975(c)(1)(E). F, regardless 
of any intent which he may have had at the time he retained C, has 
engaged in such an act because F has, in effect, exercised the 
authority, control or responsibility which makes F a fiduciary to cause 
the plan to pay F additional fees for the services. C, whose continued 
employment by P depends on F, has also engaged in such an act, because C 
has an interest in the transaction which might affect the exercise of 
C's best judgment as a fiduciary. As a result, C has dealt with plan 
assets in his own interest under section 4975(c)(1)(E).
    Example 6. F, a fiduciary of plan P with discretionary authority 
respecting the management of P, retains S, the son of F, to provide for 
a fee various kinds of administrative services necessary for the 
operation of the plan. F has engaged in an act described in section 
4975(c)(1)(E), because S is a person in whom F has an interest which may 
affect the exercise of F's best judgment as a fiduciary. Such act is not 
exempt under section 4975(d)(2) irrespective of whether the provision of 
the services by S is exempt.
    Example 7. T, one of the trustees of plan P, is president of bank B. 
The bank proposes to provide administrative services to P for a fee. T 
physically absents himself from all consideration of B's proposal and 
does not otherwise exercise any of the authority, control or 
responsibility which makes T a fiduciary to cause the plan to retain B. 
The other trustees decide to retain B. T has not engaged in an act 
described in section 4975(c)(1)(E). Further, the other trustees have not 
engaged in an act described in section 4975(c)(1)(E) merely because T is 
on the board of trustees of P. This fact alone would not make them have 
an interest in the transaction which might affect the exercise of their 
best judgment as fiduciaries.

    (b) Exemption for bank deposits--(1) In general. Section 4975(d)(4) 
exempts from the excise taxes imposed by section 4975 investment of all 
or a part of a plan's assets in deposits bearing a reasonable rate of 
interest in a bank or similar financial institution supervised by the 
United States or a State, even though such bank or similar financial 
institution is a fiduciary or other disqualified person with respect to 
the plan, if the conditions of either Sec. 54.4975-6(b)(2) or Sec. 
54.4975-6(b)(3) are met. Section 4975(d)(4) provides an exemption from 
section 4975(c)(1)(E) relating to fiduciaries dealing with the income or 
assets of plans in their own interest or for their own account), as well 
as sections 4975(c)(1) (A) through (D), because section 4975(d)(4) 
contemplates a bank or similar financial institution causing a plan for 
which it acts as a fiduciary to invest plan assets in its own deposits 
if the requirements of section 4975(d)(4) are met. However, it does not 
provide an exemption from section 4975(c)(1)(F) (relating to fidiciaries 
receiving consideration for their own personal account from any party 
dealing with a plan in connection with a transaction involving the 
income or assets of the plan). The receipt of such consideration is a 
separate transaction not described in the exemption. Section 4975(d)(4) 
does not contain an exemption from other provisions of the Code, such as 
section 401, or other provisions of law which may impose requirements or 
restrictions relating to the transactions which are exempt under section 
4975(d)(4). See, for example, the general fiduciary responsibility 
provisions of section 404 of the Act. The provisions of section 
4975(d)(4) are further limited by the flush language at the end of 
section 4975(d) (relating to transactions with owner-employees and 
related persons).
    (2) Plan covering own employees. Such investment may be made if the 
plan is one which covers only the employees of

[[Page 284]]

the bank or similar financial institution, the employees of any of its 
affiliates, or the employees of both.
    (3) Other plans--(i) General rule. Such investment may be made if 
the investment is expressly authorized by a provision of the plan or 
trust instrument or if the investment is expressly authorized (or made) 
by a fiduciary of the plan (other than the bank or similar financial 
institution or any of its affiliates) who has authority to make such 
investments, or to instruct the trustee or other fiduciary with respect 
to investments, and who has no interest in the transaction which may 
affect the exercise of such authorizing fiduciary's best judgment as a 
fiduciary so as to cause such authorization to constitute an act 
described in section 4975(c)(1) (E) or (F). Any authorization to make 
investments contained in a plan or trust instrument will satisfy the 
requirement of express authorization for investments made prior to 
November 1, 1977.


Effective November 1, 1977, in the case of a bank or similar financial 
institution that invests plan assets in deposits in itself or its 
affiliates under an authorization contained in a plan or trust 
instrument, such authorization must name such bank or similar financial 
institution and must state that such bank or similar financial 
institution may make investments in deposits which bear a reasonable 
rate of interest in itself (or in an affiliate.)
    (ii) Example. B, a bank, is the trustee of plan P's assets. The 
trust instruments give the trustee the right to invest plan assets in 
its discretion. B invests in the certificates of deposit of bank C, 
which is a fiduciary of the plan by virtue of performing certain 
custodial and administrative services. The authorization is sufficient 
for the plan to make such investment under section 4975(d)(4). Further, 
such authorization would suffice to allow B to make investments in 
deposits in itself prior to November 1, 1977. However, subsequent to 
October 31, 1977, B may not invest in deposits in itself, unless the 
plan or trust instrument specifically authorizes it to invest in 
deposits of B.
    (4) Definitions. (i) The term ``bank or similar financial 
institution'' includes a bank (as defined in section 581), a domestic 
building and loan association (as defined in section 7701(a)(19)), and a 
credit union (as defined in section 101 (6) of the Federal Credit Union 
Act).
    (ii) A person is an affiliate of a bank or similar financial 
institution if such person and such bank or similar financial 
institution would be treated as members of the same controlled group of 
corporations or as members of two or more trades or businesses under 
common control within the meaning of section 414 (b) or (c) and the 
regulations thereunder.
    (iii) The term ``deposits'' includes any account, temporary or 
otherwise, upon which a reasonable rate of interest is paid, including a 
certificate of deposit issued by a bank or similar financial 
institution.
    (c) Exemption for ancillary bank services--(1) In general. Section 
4975(d)(6) exempts from the excise taxes imposed by section 4975 the 
provision of certain ancillary services by a bank or similar financial 
institution (as defined in Sec. 54.4975-6(b)(4)(i)) supervised by the 
United States or a State to a plan for which it acts as a fiduciary if 
the conditions in Sec. 54.4975-6(c)(2) are met. Such ancillary services 
include services which do not meet the requirements of section 
4975(d)(2), because the provision of such services involves an act 
described in section 4975(c)(1)(E) (relating to fiduciaries dealing with 
the income or assets of plans in their own interest or for their own 
account) by the fiduciary bank or similar financial institution. Section 
4975(d)(6) provides an exemption from section 4975(c)(1)(E), because 
section 4975 (d)(6) contemplates the provision of such ancillary 
services without the approval of a second fiduciary (as described in 
Sec. 54.4975-6(a)(5)(ii)) if the conditions of Sec. 54.4975-6(c)(2) 
are met. Thus, for example, plan assets held by a fiduciary bank which 
are reasonably expected to be needed to satisfy current plan expenses 
may be placed by the bank in a non-interest-bearing checking account in 
the bank if the conditions of Sec. 54.4975-6(c)(2) are met, 
notwithstanding the provisions of section 4975(d)(4) (relating to 
investments in bank deposits). However, section 4975(d)(6) does not 
provide an exemption for an act described in section

[[Page 285]]

4975(c)(1)(F) (relating to fiduciaries receiving consideration for their 
own personal account from any party dealing with a plan in connection 
with a transaction involving the income or assets of the plan). The 
receipt of such consideration is a separate transaction not described in 
section 4975(d)(6).

Section 4975(d)(6) does not contain an exemption from other provisions 
of the Code, such as section 401, or other provisions of law which may 
impose requirements or restrictions relating to the transactions which 
are exempt under section 4975(d)(6). See, for example, the general 
fiduciary responsibility provisions of section 404 of the Act. The 
provisions of section 4975(d)(6) are further limited by the flush 
language at the end of section 4975(d) (relating to transactions with 
owner-employees and related persons).
    (2) Conditions. Such service must be provided:
    (i) At not more than reasonable compensation;
    (ii) Under adequate internal safeguards which assure that the 
provision of such service is consistent with sound banking and financial 
practice, as determined by Federal or State supervisory authority; and
    (iii) Only to the extent that such service is subject to specific 
guidelines issued by the bank or similar financial institution which 
meet the requirements of Sec. 54.4975-6(c)(3).
    (3) Specific guidelines. [Reserved]
    (d) Exemption for services as a fiduciary. [Reserved]
    (e) Compensation for services--(1) In general. Section 4975(d)(2) 
refers to the payment of reasonable compensation by a plan to a 
disqualified person for services rendered to the plan. Section 
4975(d)(10) and Sec. Sec. 54.4975-6(e)(2) through 54.4975-6(e)(5) 
clarify what constitutes reasonable compensation for such services.
    (2) General rule. Generally, whether compensation is ``reasonable'' 
under sections 4975(d) (2) and (10) depends on the particular facts and 
circumstances of each case.
    (3) Payments to certain fiduciaries. Under sections 4975(d) (2) and 
(10), the term ``reasonable compensation'' does not include any 
compensation to a fiduciary who is already receiving full-time pay from 
an employer or association of employers (any of whose employees are 
participants in the plan) or from an employee organization (any of whose 
members are participants in the plan), except for the reimbursement of 
direct expenses properly and actually incurred and not otherwise 
reimbursed. The restrictions of this paragraph (e)(3) do not apply to a 
disqualified person who is not a fiduciary.
    (4) Certain expenses not direct expenses. An expense is not a direct 
expense to the extent it would have been sustained had the service not 
been provided or if it represents an allocable portion of overhead 
costs.
    (5) Expense advances. Under sections 4975(d) (2) and (10), the term 
``reasonable compensation'', as applied to a fiduciary or an employee of 
a plan, includes an advance to such a fiduciary or employee by the plan 
to cover direct expenses to be properly and actually incurred by such 
person in the performance of such person's duties with the plan if:
    (i) The amount of such advance is reasonable with respect to the 
amount of the direct expense which is likely to be properly and actually 
incurred in the immediate future (such as during the next month); and
    (ii) The fiduciary or employee accounts to the plan at the end of 
the period covered by the advance for the expenses properly and actually 
incurred.
    (6) Excessive compensation. Under sections 4975(d) (2) and (10), any 
compensation which would be considered excessive under Sec. 1.162-7 
(relating to compensation for personal services which constitutes an 
ordinary and necessary trade or business expense) will not be 
``reasonable compensation''. Depending upon the facts and circumstances 
of the particular situation, compensation which is not excessive under 
Sec. 1.162-7 may, nevertheless, not be ``reasonable compensation'' 
within the meaning of sections 4975(d) (2) and (10).

[T.D. 7491, 42 FR 32385, June 24, 1977; 42 FR 37810, July 25, 1977; 43 
FR 4604, Feb. 3, 1978]



Sec. 54.4975-7  Other statutory exemptions.

    (a) [Reserved]
    (b) Loans to employee stock ownership plans--(1) Definitions. When 
used in this

[[Page 286]]

paragraph (b) and Sec. 54.4975-11, the terms listed below have the 
following meanings:
    (i) ESOP. The term ``ESOP'' refers to an employee stock ownership 
plan that meets the requirements of section 4975(e)(7) and Sec. 
54.4975-11. It is not synonymous with ``stock bonus plan.'' A stock 
bonus plan must, however, be an ESOP to engage in an exempt loan. The 
qualification of an ESOP under section 401(a) and Sec. 54.4975-11 will 
not be adversely affected merely because it engages in a non-exempt 
loan.
    (ii) Loan. The term ``loan'' refers to a loan made to an ESOP by a 
disqualified person or a loan to an ESOP which is guaranteed by a 
disqualified person. It includes a direct loan of cash, a purchase-money 
transaction, and an assumption of the obligation of an ESOP, 
``Guarantee'' includes an unsecured guarantee and the use of assets of a 
disqualified person as collateral for a loan, even though the use of 
assets may not be a guarantee under applicable state law. An amendment 
of a loan in order to qualify as an exempt loan is not a refinancing of 
the loan or the making of another loan.
    (iii) Exempt loan. The term ``exempt loan'' refers to a loan that 
satisfies the provisions of this paragraph (b). A ``nonexempt loan'' is 
one that fails to satisfy such provisions.
    (iv) Publicly traded. The term ``publicly traded'' refers to a 
security that is listed on a national securities exchange registered 
under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f) 
or that is quoted on a system sponsored by a national securities 
association registered under section 15A(b) of the Securities Exchange 
Act (15 U.S.C. 78o).
    (v) Qualifying employer security. The term ``qualifying employer 
security'' refers to a security described in Sec. 54.4975-12.
    (2) Statutory exemption--(i) Scope. Section 4975(d)(3) provides an 
exemption from the excise tax imposed under section 4975 (a) and (b) by 
reason of section 4975(c)(1) (A) through (E). Section 4975(d)(3) does 
not provide an exemption from the imposition of such tax by reason of 
section 4975(c)(1)(F), relating to fiduciaries receiving consideration 
for their own personal account from any party dealing with a plan in 
connection with a transaction involving the income or assets of the 
plan.
    (ii) Special scrutiny of transaction. The exemption under section 
4975(d)(3) includes within its scope certain transaction in which the 
potential for self-dealing by fiduciaries exists and in which the 
interests of fiduciaries may conflict with the interests of 
participants. To guard against those potential abuses, the Internal 
Revenue Service will subject these transactions to special scrutiny to 
ensure that they are primarily for the benefit of participants and their 
beneficiaries. Although the transactions need not be arranged and 
approved by an independent fiduciary, fiduciaries are cautioned to 
exercise scrupulously their discretion in approving them. For example, 
fiduciaries should be prepared to demonstrate compliance with the net 
effect test and the arm's-length standard under paragraph (b)(3)(ii) and 
(iii) of this section. Also, fiduciaries should determine that the 
transaction is truly arranged primarily in the interest of participants 
and their beneficiaries rather than, for example, in the interest of 
certain selling shareholders.
    (3) Primary benefit requirement--(i) In general. An exempt loan must 
be primarily for the benefit of the ESOP participants and their 
beneficiaries. All the surrounding facts and circumstances, including 
those described in paragraph (b) (3) (ii) and (iii) of this section, 
will be considered in determining whether the loan satisfies this 
requirement. However, no loan will satisfy the requirement unless it 
satisfies the requirements of paragraph (b) (4), (5), and (6) of this 
section.
    (ii) Net effect on plan assets. At the time that a loan is made, the 
interest rate for the loan and the price of securities to be acquired 
with the loan proceeds should not be such that plan assets might be 
drained off.
    (iii) Arm's-length standard. The terms of a loan, whether or not 
between independent parties, must, at the same time the loan is made, be 
at least as favorable to the ESOP as the terms of a comparable loan 
resulting from arm's-length negotiations between independent parties.

[[Page 287]]

    (4) Use of loan proceeds. The proceeds of an exempt loan must be 
used within a reasonable time after their receipt by the borrowing ESOP 
only for any or all of the following purposes:
    (i) To acquire qualifying employer securities.
    (ii) To repay such loan.
    (iii) To repay a prior exempt loan. A new loan, the proceeds of 
which are so used, must satisfy the provisions of this paragraph (b).

Except as provided in paragraph (b) (9) and (10) of this section or as 
otherwise required by applicable law, no security acquired with the 
proceeds of an exempt loan may be subject to a put, call, or other 
option, or buy-sell or similar arrangement while held by and when 
distributed from a plan, whether or not the plan is then an ESOP.
    (5) Liability and collateral of ESOP for loan. An exempt loan must 
be without recourse against the ESOP. Furthermore, the only assets of 
the ESOP that may be given as collateral on an exempt loan are 
qualifying employer securities of two classes: those acquired with the 
proceeds of the loan and those that were used as collateral on a prior 
exempt loan repaid with the proceeds of the current exempt loan. No 
person entitled to payment under the exempt loan shall have any right to 
assets of the ESOP other than:
    (i) Collateral given for the loan,
    (ii) Contributions (other than contributions of employers 
securities) that are made under an ESOP to meet its obligations under 
the loan, and
    (iii) Earnings attributable to such collateral and the investment of 
such contributions.

The payments made with respect to an exempt loan by the ESOP during a 
plan year must not exceed an amount equal to the sum of such 
contributions and earnings received during or prior to the year less 
such payments in prior years. Such contributions and earnings must be 
accounted for separately in the books of account of the ESOP until the 
loan is repaid.
    (6) Default. In the event of default upon an exempt loan, the value 
of plan assets transferred in satisfaction of the loan must not exceed 
the amount of default. If the lender is a disqualified person, a loan 
must provide for a transfer of plan assets upon default only upon and to 
the extent of the failure of the plan to meet the payment schedule of 
the loan. For purposes of this subparagraph (6), the making of a 
guarantee does not make a person a lender.
    (7) Reasonable rate of interest. The interest rate of a loan must 
not be in excess of a reasonable rate of interest. All relevant factors 
will be considered in determining a reasonable rate of interest, 
including the amount and duration of the loan, the security and 
guarantee (if any) involved, the credit standing of the ESOP and the 
guarantor (if any), and the interest rate prevailing for comparable 
loans. When these factors are considered, a variable interest rate may 
be reasonable.
    (8) Release from encumbrance--(i) General rule. In general, an 
exempt loan must provide for the release from encumbrance under this 
subdivision (i) of plan assets used as collateral for the loan. For each 
plan year during the duration of the loan, the number of securities 
released must equal the number of encumbered securities held immediately 
before release for the current plan year multiplied by a fraction. The 
numerator of the fraction is the amount of principal and interest paid 
for the year. The denominator of the fraction is the sum of the 
numerator plus the principal and interest to be paid for all future 
years. See Sec. 54.4975-7(b) (8) (iv). The number of future years under 
the loan must be definitely ascertainable and must be determined without 
taking into account any possible extensions or renewal periods. If the 
interest rate under the loan is variable, the interest to be paid in 
future years must be computed by using the interest rate applicable as 
of the end of the plan year. If collateral includes more than one class 
of securities, the number of securities of each class to be released for 
a plan year must be determined by applying the same fraction to each 
class.
    (ii) Special rule. A loan will not fail to be exempt merely because 
the number of securities to be released from encumbrance is determined 
solely with reference to principal payments. However, if release is 
determined with reference to principal payments only, the following 
three additional rules apply.

[[Page 288]]

The first rule is that the loan must provide for annual payments of 
principal and interest at a cumulative rate that is not less rapid at 
any time than level annual payments of such amounts for 10 years. The 
second rule is that interest included in any payment is disregarded only 
to the extent that it would be determined to be interest under standard 
loan amoritization tables. The third rule is that this subdivision, (ii) 
is not applicable from the time that, by reason of a renewal, extension, 
or refinancing, the sum of the expired duration of the exempt loan, the 
renewal period, the extension period, and the duration of a new exempt 
loan exceeds 10 years.
    (iii) Caution against plan disqualification. Under an exempt loan, 
the number of securities released from encumbrance may vary from year to 
year. The release of securities depends upon certain employer 
contributions and earnings under the ESOP. Under Sec. 54.4975-11(d)(2) 
actual allocations to participants' accounts are based upon assets 
withdrawn from the suspense account. Nevertheless, for purposes of 
applying the limitations under section 415 to these allocations, under 
Sec. 54.4975-11(a)(8)(ii) contributions used by the ESOP to pay the 
loan are treated as annual additions to participants' accounts. 
Therefore, particular caution must be exercised to avoid exceeding the 
maximum annual additions under section 415. At the same time, release 
from encumbrance in annual varying numbers may reflect a failure on the 
part of the employer to make substantial and recurring contributions to 
the ESOP which will lead to loss of qualification under section 401(a). 
The Internal Revenue Service will observe closely the operation of 
ESOP's that release encumbered securities in varying annual amounts, 
particularly those that provide for the deferral of loan payments or for 
balloon payments.
    (iv) Illustration. The general rule under paragraph (b)(8)(i) of 
this section operates as illustrated in the following example:

    Example. Corporation X establishes an ESOP that borrows $750,000 
from a bank. X guarantees the loan, which is for 15 years at 5% interest 
and is payable in level annual amounts of $72,256.72. Total payments on 
the loan are $1,083,850.80. The ESOP uses the entire loan proceeds to 
acquire 15,000 shares of X stock which is used as collateral for the 
loan. The number of securities to be released for the first year is 
1,000 shares, i.e., 15,000 shares x $72,256.72/$1,083,850.80 = 15,000 
shares x 1/15. The number of securities to be released for the second 
year is 1,000 shares, i.e., 14,000 shares x $72,256.72/$1,011,594.08 = 
14,000 shares x 1/14. If all loan payments are made as originally 
scheduled, the number of securities released in each succeeding year of 
the loan will also be 1,000.

    (9) Right of first refusal. Qualifying employer securities acquired 
with proceeds of an exempt loan may, but need not, be subject to a right 
of first refusal. However, any such right must meet the requirements of 
this subparagraph (9). Securities subject to such right must be stock or 
an equity security, or a debt security convertible into stock or an 
equity security. Also, the securities must not be publicly traded at the 
time the right may be exercised. The right of first refusal must be in 
favor of the employer, the ESOP, or both in any order of priority. The 
selling price and other terms under the right must not be less favorable 
to the seller than the greater of the value of the security determined 
under Sec. 54.4975-11(d)(5), or the purchase price and other terms 
offered by a buyer, other than the employer or the ESOP, making a good 
faith offer to purchase the security. The right of first refusal must 
lapse no later than 14 days after the security holder gives written 
notice to the holder of the right that an offer by a third party to 
purchase the security has been received.
    (10) Put option. A qualifying employer security acquired with the 
proceeds of an exempt loan by an ESOP after September 30, 1976, must be 
subject to a put option if it is not publicly traded when distributed or 
if it is subject to a trading limitation when distributed. For purposes 
of subparagraph (10), a ``trading limitation'' on a security is a 
restriction under any Federal or state securities law, any regulation 
thereunder, or an agreement, not prohibited by this paragraph (b), 
affecting the security which would make the security not as freely 
tradable as one not subject to such restriction. The put option must be 
exercisable only by a participant, by the participant's donees, or by

[[Page 289]]

a person (including an estate or its distributee) to whom the security 
passes by reason of a participant's death. (Under this subparagraph 
(10), participant means a participant and beneficiaries of the 
participant under the ESOP.) The put option must permit a participant to 
put the security to the employer. Under no circumstances may the put 
option bind the ESOP. However, it may grant the ESOP an option to assume 
the rights and obligations of the employer at the time that the put 
option is exercised. If it is known at the time a loan is made that 
Federal or state law will be violated by the employer's honoring such 
put option, the put option must permit the security to be put, in a 
manner consistent with such law, to a third party (e.g., an affiliate of 
the employer or a shareholder other than the ESOP) that has substantial 
net worth at the time the loan is made and whose net worth is reasonably 
expected to remain substantial.
    (11) Duration of put option--(i) General rule. A put option must be 
exercisable at least during a 15-month period which begins on the date 
the security subject to the put option is distributed by the ESOP.
    (ii) Special rule. In the case of a security that is publicly traded 
without restriction when distributed but ceases to be so traded within 
15 months after distribution, the employer must notify each security 
holder in writing on or before the tenth day after the date the security 
ceases to be so traded that for the remainder of the 15-month period the 
security is subject to a put option. The number of days between such 
tenth day and the date on which notice is actually given, if later than 
the tenth day, must be added to the duration of the put option. The 
notice must inform distributees of the terms of the put options that 
they are to hold. Such terms must satisfy the requirements of paragraph 
(b) (10) through (12) of this section.
    (12) Other put option provisions--(i) Manner of exercise. A put 
option is exercised by the holder notifying the employer in writing that 
the put option is being exercised.
    (ii) Time excluded from duration of put option. The period during 
which a put option is exercisable does not include any time when a 
distributee is unable to exercise it because the party bound by the put 
option is prohibited from honoring it by applicable Federal or state 
law.
    (iii) Price. The price at which a put option must be exercisable is 
the value of the security, determined under Sec. 54.4975-11(d)(5).
    (iv) Payment terms. The provisions for payment under a put option 
must be reasonable. The deferral of payment is reasonable if adequate 
security and a reasonable interest rate are provided for any credit 
extended and if the cumulative payments at any time are no less than the 
aggregate of reasonable periodic payments as of such time. Periodic 
payments are reasonable if annual installments, beginning with 30 days 
after the date the put option is excercised, are substantially equal. 
Generally, the payment period may not end more than 5 years after the 
date the put option is exercised. However, it may be extended to a date 
no later than the earlier of 10 years from the date the put option is 
exercised or the date the proceeds of the loan used by the ESOP to 
acquire the security subject to the put option are entirely repaid.
    (v) Payment restrictions. Payment under a put option may be 
restricted by the terms of a loan, including one used to acquire a 
security subject to a put option made before November 1, 1977. 
Otherwise, payment under a put option must not be restricted by the 
provisions of a loan or any other arrangement, including the terms of 
the employer's articles of incorporation, unless so required by 
applicable state law.
    (13) Other terms of loan. An exempt loan must be for a specific 
term. Such loan may not be payable at the demand of any person, except 
in the case of default.
    (14) Status of plan as ESOP. To be exempt, a loan must be made to a 
plan that is an ESOP at the time of such loan. However, a loan to a plan 
formally designated as an ESOP at the time of the loan that fails to be 
an ESOP because it does not comply with section 401(a) of the Code or 
Sec. 54.4975-11 will be exempt as of the time of such

[[Page 290]]

loan if the plan is amended retroactively under section 401(b) or Sec. 
54.4975-11(a)(4).
    (15) Special rules for certain loans--(i) Loans made before January 
1, 1976. A loan made before January 1, 1976, or made afterwards under a 
binding agreement in effect on January 1, 1976 (or under renewals 
permitted by the terms of the agreement on that date) is exempt for the 
entire period of the loan if it otherwise satisfies the provisions of 
this paragraph (b) for such period, even though it does not satisfy the 
following provisions of this section: the last sentence of paragraph (b) 
(4) and all of paragraph (b) (5), (6), (8) (i) and (ii), and (9) through 
(13), inclusive.
    (ii) Loans made after December 31, 1975, but before November 1, 
1977. A loan made after December 31, 1975, but before November 1, 1977 
or made afterwards under a binding agreement in effect on November 1, 
1977 (or under renewals permitted by the terms of the agreement on that 
date) is exempt for the entire period of the loan if it otherwise 
satisfies the provisions of this paragraph (b) for such period even 
though it does not satisfy the following provisions of this section: 
paragraph (b) (6) and (9) and the three additional rules listed in 
paragraph (b) (8) (ii).
    (iii) Release rule. Notwithstanding paragraph (b) (15) (i) and (ii) 
of this section, if the proceeds of a loan are used to acquire 
securities after November 1, 1977, the loan must comply by such date 
with the provisions of paragraph (b) (8) of this section.
    (iv) Default rule. Notwithstanding paragraph (b) (15) (i) and (ii) 
of this section, a loan by a disqualified person other than a guarantor 
must meet the requirements of paragraph (b) (6) of this section. A loan 
will meet these requirements if it is retroactively amended before 
November 1, 1977 to meet these requirements.
    (v) Put option rule. With respect to a security distributed before 
November 1, 1977, the put option provisions of paragraph (b) (10), (11), 
and (12) of this section will be deemed satisfied as of the date the 
security is distributed if by December 31, 1977, the security is subject 
to a put option satisfying such provisions, the security is subject to a 
put option satisfying such provisions. For purposes of satisfying such 
provisions, the security will be deemed distributed on the date the put 
option is issued. However, the put option provisions need not be 
satisfied with respect to a security that is not owned on November 1, 
1977, by a person in whose hands a put option must be exercisable.

(Sec. 4975 (e) (7), (88 Stat. 976; 26 U.S.C. 4975 (e) (7)))

[T.D. 7506, 42 FR 44391, Sept. 2, 1977]



Sec. 54.4975-9  Definition of ``fiduciary''.

    (a)-(b) [Reserved]
    (c) Investment advice. (1) A person shall be deemed to be rendering 
``investment advice'' to an employee benefit plan, within the meaning of 
section 4975(e)(3)(B) and this paragraph, only if:
    (i) Such person renders advice to the plan as to the value of 
securities or other property, or makes recommendations as to the 
advisability of investing in, purchasing, or selling securities or other 
property; and
    (ii) Such person either directly or indirectly (e.g., through or 
together with any affiliate):
    (A) Has discretionary authority or control, whether or not pursuant 
to agreement, arrangement or understanding, with respect to purchasing 
or selling securities or other property for the plan; or
    (B) Renders any advice described in paragraph (c)(1)(i) of this 
section on a regular basis to the plan pursuant to a mutual agreement, 
arrangement or understanding, written or otherwise, between such person 
and the plan or a fiduciary with respect to the plan, that such services 
will serve as a primary basis for investment decisions with respect to 
plan assets, and that such person will render individualized investment 
advice to the plan based on the particular needs of the plan regarding 
such matters as, among other things, investment policies or stategy, 
overall portfolio composition, or diversification of plan investments.
    (2) A person who is a fiduciary with respect to a plan by reason of 
rendering investment advice (as defined in paragraph (c)(1) of this 
section) for a fee or other compensation, direct or indirect, with 
respect to any moneys or other property of such plan, or having any

[[Page 291]]

authority or responsibility to do so, shall not be deemed to be a 
fiduciary regarding any assets of the plan with respect to which such 
person does not have any discretionary authority, discretionary control 
or discretionary responsibility, does not exercise any authority or 
control, does not render investment advice (as defined in paragraph 
(c)(1) of this section) for a fee or other compensation, and does not 
have any authority or responsibility to render such investment advice, 
provided that nothing in this paragraph shall be deemed to:
    (i) Exempt such person from the provisions of section 405(a) of the 
Employee Retirement Income Security Act of 1974 concerning liability for 
fiduciary breaches by other fiduciaries with respect to any assets of 
the plan; or
    (ii) Exclude such person from the definition of the term 
disqualified person (as set forth in section 4975(e)(2)) with respect to 
any assets of the plan.
    (d) Execution of securities transactions. (1) A person who is a 
broker or dealer registered under the Securities Exchange Act of 1934, a 
reporting dealer who makes primary markets in securities of the United 
States Government or of an agency of the United States Government and 
reports daily to the Federal Reserve Bank of New York its positions with 
respect to such securities and borrowings thereon, or a bank supervised 
by the United States or a State, shall not be deemed to be a fiduciary, 
within the meaning of section 4975(e)(3), with respect to an employee 
benefit plan solely because such person executes transactions for the 
purchase or sale of securities on behalf of such plan in the ordinary 
course of its business as a broker, dealer, or bank, pursuant to 
instructions of a fiduciary with respect to such plan, if:
    (i) Neither the fiduciary nor any affiliate of such fiduciary is 
such broker, dealer, or bank; and
    (ii) The instructions specify (A) the security to be purchased or 
sold, (B) a price range within which such security is to be purchased or 
sold, or, if such security is issued by an open-end investment company 
registered under the Investment Company Act of 1940 (15 U.S.C. 80a-1, et 
seq.), a price which is determined in accordance with Rule 22c-1 under 
the Investment Company Act of 1940 (17 CFR 270.22c-1), (C) a time span 
during which such security may be purchased or sold (not to exceed five 
business days), and (D) the minimum or maximum quantity of such security 
which may be purchased or sold within such price range, or, in the case 
of security issued by an open-end investment company registered under 
the Investment Company Act of 1940, the minimum or maximum quantity of 
such security which may be purchased or sold, or the value of such 
security in dollar amount which may be purchased or sold, at the price 
referred to in paragraph (d)(1)(ii)(B) of this section.
    (2) A person who is a broker-dealer, reporting dealer, or bank which 
is a fiduciary with respect to an employee benefit plan solely by reason 
of the possession or exercise of discretionary authority or 
discretionary control in the management of the plan or the management or 
disposition of plan assets in connection with the execution of a 
transaction or transactions for the purchase or sale of securities on 
behalf of such plan which fails to comply with the provisions of 
paragraph (d)(1) of this section, shall not be deemed to be a fiduciary 
regarding any assets of the plan with respect to which such broker-
dealer, reporting dealer or bank does not have any discretionary 
authority, discretionary control or discretionary responsibility, does 
not exercise any authority or control, does not render investment advice 
(as defined in paragraph (c)(1) of this section) for a fee or other 
compensation, and does not have any authority or responsibility to 
render such investment advice, provided that nothing in this paragraph 
shall be deemed to:
    (i) Exempt such broker-dealer, reporting dealer, or bank from the 
provisions of section 405(a) of the Employee Retirement Income Security 
Act of 1974 concerning liability for fiduciary breaches by other 
fiduciaries with respect to any assets of the plan; or
    (ii) Exclude such broker-dealer, reporting dealer, or bank from the 
definition of the term disqualified person (as set forth in section 
4975(e)(2)) with respect to any assets of the plan.

[[Page 292]]

    (e) Affiliate and control. (1) For purposes of paragraphs (c) and 
(d) of this section, an ``affiliate'' of a person shall include:
    (i) Any person directly or indirectly, through one or more 
intermediaries, controlling, controlled by, or under common control with 
such person;
    (ii) Any officer, director, partner, employee or relative (as 
defined in section 4975(e)(6)) of such person; and
    (iii) Any corporation or partnership of which such person is an 
officer, director or partner.
    (2) For purposes of this paragraph, the term control means the power 
to exercise a controlling influence over the management or policies of a 
person other than an individual.

[T.D. 7386, 40 FR 50841, Oct. 31, 1975]



Sec. 54.4975-11  ``ESOP'' requirements.

    (a) In general--(1) Type of plan. To be an ``ESOP'' (employee stock 
ownership plan), a plan described in section 4975(e)(7)(A) must meet the 
requirements of this section. See section 4975(e)(7)(B).
    (2) Designation as ESOP. To be an ESOP, a plan must be formally 
designated as such in the plan document.
    (3) Continuing loan provisions under plan--(i) Creation of 
protections and rights. The terms of an ESOP must formally provide 
participants with certain protections and rights with respect to plan 
assets acquired with the proceeds of an exempt loan. These protections 
and rights are those referred to in the third sentence of Sec. 54.4975-
7(b)(4), relating to put, call, or other options and to buy-sell or 
similar arrangements, and in Sec. 54.4975-7(b) (10), (11), and (12), 
relating to put options.
    (ii) ``Nonterminable'' protections and rights. The terms of an ESOP 
must also formally provide that these protections and rights are 
nonterminable. Thus, if a plan holds or has distributed securities 
acquired with the proceeds of an exempt loan and either the loan is 
repaid or the plan ceases to be an ESOP, these protections and rights 
must continue to exist under the terms of the plan. However, the 
protections and rights will not fail to be nonterminable merely because 
they are not exercisable under Sec. 54.4975-7(b) (11) and (12)(ii). For 
example, if, after a plan ceases to be an ESOP, securities acquired with 
the proceeds of an exempt loan cease to be publicly traded, the 15-month 
period prescribed by Sec. 54.4975-7(b)(11) includes the time when the 
securities are publicly traded.
    (iii) No incorporation by reference of protections and rights. The 
formal requirements of paragraph (a)(3) (i) and (ii) of this section 
must be set forth in the plan. Mere reference to the third sentence of 
Sec. 54.4975-7(b)(4) and to the provisions of Sec. 54.4975-7(b) (10), 
(11), and (12) is not sufficient.
    (iv) Certain remedial amendments. Notwithstanding the limits under 
paragraph (a) (4) and (10) of this section on the retroactive effect of 
plan amendments, a remedial plan amendment adopted before December 31, 
1979, to meet the requirements of paragraph (a)(3) (i) and (ii) of this 
section is retroactively effective as of the later of the date on which 
the plan was designated as an ESOP or November 1, 1977.
    (4) Retroactive amendment. A plan meets the requirements of this 
section as of the date that it is designated as an ESOP if it is amended 
retroactively to meet, and in fact does meet, such requirements at any 
of the following times:
    (i) 12 months after the date on which the plan is designated as an 
ESOP;
    (ii) 90 days after a determination letter is issued with respect to 
the qualification of the plan as an ESOP under this section, but only if 
the determination is requested by the time in paragraph (a)(4)(i) of 
this section; or
    (iii) A later date approved by the district director.
    (5) Addition to other plan. An ESOP may form a portion of a plan the 
balance of which includes a qualified pension, profit-sharing, or stock 
bonus plan which is not an ESOP. A reference to an ESOP includes an ESOP 
that forms a portion of another plan.
    (6) Conversion of existing plan to an ESOP. If an existing pension, 
profit-sharing, or stock bonus plan is converted into an ESOP, the 
requirements of section 404 of the Employee Retirement Income Security 
Act of 1974 (ERISA) (88 Stat. 877), relating to fiduciary duties, and 
section 401(a) of the Code, relating to requirements for

[[Page 293]]

plans established for the exclusive benefit of employees, applying to 
such conversion. A conversion may constitute a termination of an 
existing plan. For definition of a termination, see the regulations 
under section 411(d)(3) of the Code and section 4041(f) of ERISA.
    (7) Certain arrangements barred--(i) Buy-sell agreements. An 
arrangement involving an ESOP that creates a put option must not provide 
for the issuance of put options other than as provided under Sec. 
54.4975-7(b) (10), (11) and (12). Also, an ESOP must not otherwise 
obligate itself to acquire securities from a particular security holder 
at an indefinite time determined upon the happening of an event such as 
the death of the holder.
    (ii) Integrated plans. A plan designated as an ESOP after November 
1, 1977, must not be integrated directly or indirectly with 
contributions or benefits under title II of the Social Security Act or 
any other State or Federal law. ESOP's established and integrated before 
such date may remain integrated. However, such plans must not be amended 
to increase the integration level or the integration percentage. Such 
plans may in operation continue to increase the level of integration if 
under the plan such increase is limited by reference to a criterion 
existing apart from the plan.
    (8) Effect of certain ESOP provisions on section 401(a) status--(i) 
Exempt loan requirements. An ESOP will not fail to meet the requirements 
of section 401(a)(2) merely because it gives plan assets as collateral 
for an exempt loan under Sec. 54.4975-7(b)(5) or uses plan assets under 
Sec. 54.4975-7(b)(6) to repay and exempt loan in the event of default.
    (ii) Individual annual contribution limitation. An ESOP will not 
fail to meet the requirements of section 401(a)(16) merely because 
annual additions under section 415(c) are calculated with respect to 
employer contributions used to repay an exempt loan rather than with 
respect to securities allocated to participants.
    (iii) Income pass-through. An ESOP will not fail to meet the 
requirements of section 401(a) merely because it provides for the 
current payment of income under paragraph (f)(3) of this section.
    (9) Transitional rules for ESOP's established before November 1, 
1977. A plan established before November 1, 1977 that otherwise 
satisfies the provisions of this section constitutes an ESOP if it is 
amended by December 31, 1977, to comply from November 1, 1977 with this 
section even though before November 1, 1977 the plan did not satisfy 
paragraphs (c) and (d) (2), (4), and (5) of this section.
    (10) Additional transitional rules. Notwithstanding paragraph (a)(9) 
of this section, a plan established before November 1, 1977, that 
otherwise satisfies the provisions of this section constitutes an ESOP 
if by December 31, 1977, it is amended to comply from November 1, 1977, 
with this section even though before such date the plan did not satisfy 
the following provisions of this section:
    (i) Paragraph (a) (3) and (8) (iii);
    (ii) The last sentence of paragraph (d)(3); and
    (iii) Paragraph (f)(3).
    (b) Plan designed to invest primarily in qualifying employer 
securities. A plan constitutes an ESOP only if the plan specifically 
states that it is designed to invest primarily in qualifying employer 
securities. Thus, a stock bonus plan or a money purchase pension plan 
constituting an ESOP may invest part of its assets in other than 
qualifying employer securities. Such plan will be treated the same as 
other stock bonus plans or money purchase pension plans qualified under 
section 401a with respect to those investments.
    (c) Suspense account. All assets acquired by an ESOP with the 
proceeds of an exempt loan under section 4975(d)(3) must be added to and 
maintained in a suspense account. They are to be withdrawn from the 
suspense account by applying Sec. 54.4975-7(b) (8) and (15) as if all 
securities in the suspense account were encumbered. Such assets acquired 
before November 1, 1977, must be withdrawn by applying Sec. 54.4975-
7(b)(8) or the provision of the loan that controls release from 
encumbrance. Assets in such suspense accounts are assets of the ESOP. 
Thus, for example, such assets are subject to section 401(a)(2).

[[Page 294]]

    (d) Allocations to accounts of participants--(1) In general. Except 
as provided in this section, amounts contributed to an ESOP must be 
allocated as provided under Sec. 1.401-1(b)(ii) and (iii) of this 
chapter, and securities acquired by an ESOP must be accounted for as 
provided under Sec. 1.402(a)-1(b)(2)(ii) of this chapter.
    (2) Assets withdrawn from suspense account. As of the end of each 
plan year, the ESOP must consistently allocate to the participants' 
accounts non-monetary units representing participants' interests in 
assets withdrawn from the suspense account.
    (3) Income. Income with respect to securities acquired with the 
proceeds of an exempt loan must be allocated as income of the plan 
except to the extent that the ESOP provides for the use of income from 
such securities to repay the loan. Certain income may be distributed 
currently under paragraph (f)(3) of this section.
    (4) Forfeitures. If a portion of a participant's account is 
forfeited, qualifying employer securities allocated under paragraph 
(d)(2) of this section must be forfeited only after other assets. If 
interests in more than one class of qualifying employer securities have 
been allocated to the participant's account, the participant must be 
treated as forfeiting the same proportion of each such class.
    (5) Valuation. For purposes of Sec. 54.4975-7(b) (9) and (12) and 
this section, valuations must be made in good faith and based on all 
relevant factors for determining the fair market value of securities. In 
the case of a transaction between a plan and a disqualified person, 
value must be determined as of the date of the transaction. For all 
other purposes under this subparagraph (5), value must be determined as 
of the most recent valuation date under the plan. An independent 
appraisal will not in itself be a good faith determination of value in 
the case of a transaction between a plan and a disqualified person. 
However, in other cases, a determination of fair market value based on 
at least an annual appraisal independently arrived at by a person who 
customarily makes such appraisals and who is independent of any party to 
a transaction under Sec. 54.4975-7(b) (9) and (12) will be deemed to be 
a good faith determination of value.
    (e) Multiple plans--(1) General rule. An ESOP may not be considered 
together with another plan for purposes of applying section 401(a) (4) 
and (5) or section 410(b) unless:
    (i) The ESOP and such other plan exist on November 1, 1977, or
    (ii) Paragraph (e)(2) of this section is satisfied.
    (2) Special rule for combined ESOP's. Two or more ESOP's, one or 
more of which does not exist on November 1, 1977, may be considered 
together for purposes of applying section 401(a) (4) and (5) or section 
410(b) only if the proportion of qualifying employer securities to total 
plan assets is substantially the same for each ESOP and:
    (i) The qualifying employer securities held by all ESOP's are all of 
the same class; or
    (ii) The ratios of each class held to all such securities held is 
substantially the same for each plan.
    (3) Amended coverage, contribution, or benefit structure. For 
purposes of paragraph (e)(1)(i) of this section, if the coverage, 
contribution, or benefit structure of a plan that exists on November 1, 
1977 is amended after that date, as of the effective date of the 
amendment, the plan is no longer considered to be a plan that exists on 
November 1, 1977.
    (f) Distribution--(1) In general. Except as provided in paragraph 
(f) (2) and (3) of this section, with respect to distributions, a 
portion of an ESOP consisting of stock bonus plan or a money purchase 
pension plan is not to be distinguished from other such plans under 
section 401(a). Thus, for example, benefits distributable from the 
portion of an ESOP consisting of a stock bonus plan are distributable 
only in stock of the employer. Also, benefits distributable from the 
money-purchase portion of the ESOP may be, but are not required to be, 
distributable in qualifying employer securities.
    (2) Exempt loan proceeds. If securities acquired with the proceeds 
of an exempt loan available for distribution consist of more than one 
class, a distributee must receive substantially the same proportion of 
each such class.

[[Page 295]]

However, as indicated in paragraph (f)(1) of this section, benefits 
distributable from the portion of an ESOP consisting of a stock bonus 
plan are distributable only in stock of the employer.
    (3) Income. Income paid with respect to qualifying employer 
securities acquired by an ESOP in taxable years beginning after December 
31, 1974, may be distributed at any time after receipt by the plan to 
participants on whose behalf such securities have been allocated. 
However, under an ESOP that is a stock bonus plan, income held by the 
plan for a 2-year period or longer must be distributed under the general 
rules described in paragraph (f)(1) of this section. (See the last 
sentence of section 803(h), Tax Reform Act of 1976.)

(Sec. 4975(e)(7), (88 Stat. 976; 26 U.S.C. 4975(e)(7)))

[T.D. 7506, 42 FR 44393, Sept. 2, 1977, as amended by T.D. 7571, 44 FR 
1978, Jan. 9, 1979]



Sec. 54.4975-12  Definition of the term ``qualifying employer security''.

    (a) In general. For purposes of section 4975(e)(8) and this section, 
the term ``qualifying employer security'' means an employer security 
which is:
    (1) Stock or otherwise an equity security, or
    (2) A bond, debenture, note, or certificate or other evidence of 
indebtedness which is described in paragraphs (1), (2), and (3) of 
section 503(e).
    (b) Special rule. In determining whether a bond, debenture, note, or 
certificate or other evidence of indebtedness is described in paragraphs 
(1), (2), and (3) of section 503(e), any organization described in 
section 401(a) shall be treated as an organization subject to the 
provisions of section 503.

(Sec. 4975(e)(7) (88 Stat. 976; 26 U.S.C. 4975(e)(7)))

[T.D. 7506, 42 FR 44394, Sept. 2, 1977]



Sec. 54.4975-14  Election to pay an excise tax for certain pre-1975 
prohibited transactions.

    (a) In general. Section 2003(c)(1)(B) of the Employee Retirement 
Income Security Act of 1974 (88 Stat. 978) provides an election to pay 
an excise tax by certain persons involved prior to 1975 in prohibited 
transactions within the meaning of section 503 (b) or (g).
    (b) Effect of election. If a valid election is made under this 
section with respect to a particular transaction, any loss of exemption 
under section 501(a) because of a prohibited transaction within the 
meaning of section 503 (b) or (g) shall not apply. Instead, the person 
who made the election referred to in this section shall be subject to 
the taxes which would have been imposed by section 4975 (a) or (b) as 
though section 4975 had imposed a tax in respect of the transaction. 
(However, section 4975(f)(1), relating to joint and several liability, 
shall not apply to any person who has not made an election under this 
section, and interest for late payment of tax shall not begin to accrue 
until after the date of the election.) Such an election is irrevocable. 
However, the making of the election does not affect the application of 
section 6501 for purposes of assessment and collection of tax and 
section 6511 for purposes of filing a claim for credit or refund with 
respect to taxpayers and to taxable years of taxpayers whose tax 
liability is or may be affected by reason of the nonapplication of a 
denial of exempt status.
    (c) Method of election. A person shall make the election referred to 
in this section by filing the form issued for such purpose by the 
Internal Revenue Service, including therein the information required by 
such form and the instructions issued with respect thereto, and by 
paying the tax which the taxpayer indicates is due at the time the 
return is filed. To be valid the election must be made prior to the 
later of December 6, 1976, or 120 days after the date of notification 
referred to in Sec. 1.503(a)-1(b) of this chapter (Income Tax 
Regulations), relating to loss of exemption for certain prohibited 
transactions. If there has been no notification of loss of exemption, 
the election may be made at any time. However, these limitations do not 
preclude an agreement between the disqualified person and the district 
director to extend the time within which the election is permitted.
    (d) Computation of section 4975 excise tax. To the extent 
applicable, and solely for purposes associated with the

[[Page 296]]

payment of a section 4975 excise tax under the election referred to in 
this section, Sec. 53.4941(e)-1 of this chapter (Foundation Excise Tax 
Regulations) is controlling.

(Sec. 2003(c)(1)(B) of the Employee Retirement Income Security Act of 
1974 (88 Stat. 978))

[T.D. 7489, 42 FR 27882, June 1, 1977]



Sec. 54.4975-15  Other transitional rules.

    (a)-(c) [Reserved]
    (d) Provision of certain services until June 30, 1977--(1) In 
general. Section 2003(c)(2)(D) of the Employee Retirement Income 
Security Act of 1974 (the Act) (88 Stat. 979) provides that section 4975 
shall not apply to the provision of services before June 30, 1977, 
between a plan and a disqualified person if the three requirements 
contained in section 2003(c)(2)(D) of the Act are met. The first 
requirement is that such services must be provided either (in) under a 
binding contract in effect on July 1, 1974 (or pursuant to a renewal or 
modification of such contract); or (ii) by a disqualified person who 
ordinarily and customarily furnished such services on June 30, 1974. The 
second requirement is that the services be provided on terms that remain 
at least as favorable to the plan as an arm's-length transaction with an 
unrelated party would be.

For this purpose, such services are provided on terms that remain at 
least as favorable to the plan as an arms-length transaction with an 
unrelated party would be if, at the time of execution (or renewal) of 
such binding contract, the contract (or renewal) is on terms at least as 
favorable to the plan as an arm's-length transaction with an unrelated 
party would be. However, if in a normal commercial setting an unrelated 
party in the position of the plan could be expected to insist upon a 
renegotiation or termination of a binding contract, the plan must so 
act. Thus, for example, if a disqualified person provides services to a 
plan on a month-to-month basis, and a party in the position of the plan 
could be expected to renegotiate the price paid under such contract 
because of a decline in the fair market value of such services, the plan 
must so act in order to avoid participation in a prohibited transaction. 
The third requirement is that the provision of services must not be, or 
have been, at the time of such provision a prohibited transaction within 
the meaning of section 503(b) or the corresponding provisions of prior 
law. If these three requirements are met, section 4975 will apply 
neither to services provided before June 30, 1977 (both to customers to 
whom such services were being provided on June 30, 1974, and to new 
customers) nor to the receipt of compensation therefor. Thus, if these 
three requirements are met, section 4975 will not apply until June 30, 
1977, to the provision of services to a plan by a disqualified person 
(including a fiduciary) even if such services could not be furnished 
pursuant to the exemption provisions of sections 4975(d)(2) or (6) and 
Sec. 54.4975-6. For example, if the three requirements of section 
2003(c)(2)(D) of the Act are met, a person serving as fiduciary to a 
plan who already receives full-time pay from an employer or an 
association of employers, whose employees are participants in such plan, 
or from an employee organization whose members are participants in such 
plan, may continue to receive reasonable compensation from the plan for 
services rendered to the plan before June 30, 1977. Similarly, until 
June 30, 1977, a plan consultant who may be a fiduciary because of the 
nature of the consultative and administrative services being provided 
may, if these three requirements are met, continue to cause the sale of 
insurance to the plan and continue to receive commissions for such sales 
from the insurance company writing the policy. Further, if the three 
requirements of section 2003 (c)(2)(D) of the Act are met, a securities 
broker dealer who renders investment advice to a plan for a fee, thereby 
becoming a fiduciary may furnish other services to the plan, such as 
brokerage services, and receives compensation therefor. Also, if a 
registered representative of such a broker-dealer were a fiduciary, the 
registered representative may receive compensation, including 
commissions, for brokerage services performed before June 30, 1977.
    (2) Persons deemed to be June 30, 1974, service providers. A 
disqualified person with respect to a plan which did not,

[[Page 297]]

on June 30, 1974, ordinarily and customarily furnish a particular 
service, will nevertheless be considered to have ordinarily and 
customarily furnished such service on June 30, 1974, for purposes of 
this section and section 2003(c)(2)(D) of the Act, if either of the 
following conditions are met:
    (i) At least 50 percent of the outstanding beneficial interests of 
such disqualified person are owned directly or through one or more 
intermediaries by the same person or persons who owned, directly or 
through one or more intermediaries, at least 50 percent of the 
outstanding beneficial interests of a person who ordinarily and 
customarily furnished such service on June 30, 1974; or
    (ii) Control, or the power to exercise a controlling influence over 
the management and policies of such disqualified person is possessed, 
directly or through one or more intermediaries, by the same person or 
persons who possessed directly or through one or more intermediaries 
control, or the power to exercise a controlling influence over the 
management and policies of a person who ordinarily and customarily 
furnished such service on June 30, 1974. For purposes of this paragraph 
(d)(2) a person shall be deemed to be an ``intermediary'' of another 
person if at least 50 percent of the outstanding beneficial interests of 
such person are owned by such other person, directly or indirectly, or 
if such other person controls or has the power to exercise a controlling 
influence over the management and policies of such person.
    (3) Examples. The principals of Sec. 54.4975-15(d)(2) may be 
illustrated by the following examples.

    Example 1. A owns 50 percent of the outstanding beneficial interests 
of ABC Partnership which ordinarily and customarily furnished certain 
services on June 30, 1974. On July 2, 1974, ABC Partnership was 
incorporated into ABC Corporation with one class of stock outstanding. A 
owns 50 percent of the shares of such stock. ABC Corporation furnishes 
the same services that were furnished by ABC Partnership on June 30, 
1974. ABC Corporation will be deemed to have ordinarily and customarily 
furnished such services on June 30, 1974, for purposes of section 
2003(c)(2)(D) of the Act.
    Example 2. A and B together own 100 percent of the beneficial 
interests of AB Partnership, which ordinarily and customarily furnished 
certain services on June 30, 1974. On September 1, 1974, AB Partnership 
was incorporated into AB Corporation with one class of stock 
outstanding. A and B each own 20 percent of such outstanding class of 
stock and together have control over the management and policies of AB 
Corporation. AB Corporation furnishes the same services that were 
furnished by AB Partnership on June 30, 1974. AB Corporation will be 
deemed to have ordinarily and customarily furnished such services on 
June 30, 1974, for purposes of section 2003(c)(2)(D) of the Act.
    Example 3. On June 30, 1974, M Corporation was ordinarily and 
customarily furnishing certain services. On that date, X, Y and Z 
together owned 50 percent of all classes of the outstanding shares of M 
Corporation. On January 28, 1975, all of the shareholders of M 
Corporation exchanged their shares in M Corporation for shares of a new 
N Corporation. As a result of that exchange, X, Y and Z together own 50 
percent of the common stock of N Corporation, the only class of N 
Corporation stock outstanding after the exchange. N Corporation 
furnishes the services formerly furnished by M Corporation. N 
Corporation will be deemed to have ordinarily and customarily furnished 
such services on June 30, 1974, for purposes of section 2003(c)(2)(D) of 
the Act.
    Example 4. I Corporation ordinarily and customarily furnished 
certain services on June 30, 1974. On November 3, 1975, I Corporation 
organizes a wholly owned subsidiary, S Corporation, which furnishes the 
same services ordinarily and customarily furnished by I Corporation on 
June 30, 1974. S Corporation will be deemed to have ordinarily and 
customarily furnished such services on June 30, 1974, for purposes of 
section 2003(c)(2)(D) of the Act.
    Example 5. X Corporation, wholly-owned and controlled by A, 
ordinarily and customarily furnished certain services on June 30, 1974. 
Y Corporation did not perform such services on that date. On January 2, 
1976, X Corporation is merged into Y Corporation and although A received 
less than 50 percent of the total outstanding shares of Y Corporation, 
after such merger A has control over the management and policies of Y 
Corporation. Y Corporation furnishes the same services that were 
formerly furnished by X Corporation. Y Corporation will be deemed to 
have ordinarily and customarily furnished such services on June 30, 
1974, for purposes of section 2003(c)(2)(D) of the Act.

[T.D. 7491, 42 FR 32388, June 24, 1977]



Sec. 54.4976-1T  Questions and answers relating to taxes with respect to
welfare benefit funds (temporary).

    Q-1: What does section 4976 provide?
    A-1: Section 4976 imposes a tax on employers who provide 
disqualified

[[Page 298]]

benefits through a welfare benefit fund. The tax imposed is equal to 100 
percent of the disqualified benefit.
    Q-2: What constitutes a disqualified benefit?
    A-2: A disqualified benefit is (a) any post-retirement medical or 
life insurance benefit provided with respect to a key employee (as 
defined in section 419A(d)(3)) through a welfare benefit fund if a 
separate account is required to be established for such employee under 
section 419A(d) and the cost for such coverage is not charged against or 
paid from such separate account; (b) any post-retirement medical or life 
insurance benefit provided through a welfare benefit fund with respect 
to an individual in whose favor discrimination is prohibited unless the 
plan of which the fund is a part meets the requirements of section 
505(b) with respect to that benefit; and (c) any portion of the fund 
which reverts to the benefit of the employer. A post-retirement medical 
or life insurance benefit provided with respect to a key employee will 
not constitute a disqualified benefit even though such benefit is not 
provided through a separate account if the cost of such benefit is paid 
by the employer in the taxable year in which the benefit is provided and 
there is not (and there is not required to be) a separate account with 
an outstanding credit balance maintained for the key employee.
    Q-3: What is the effective date of section 4976?
    A-3: (a) Generally, section 4976 applies to disqualified benefits 
provided by a welfare benefit fund after December 31, 1985. However, a 
disqualified benefit, as defined in section 4976(b)(1) or (2), is not 
subject to section 4976(a) if it is provided from ``existing reserves 
for post-retirement medical or life insurance benefits'' that are within 
the transition rule set forth in section 512(a)(3)(E)(iii) and Q&A-4 of 
Sec. 1.512(a)-5T (or would be if such transition rule applied to such 
welfare benefit fund). For example, if a welfare benefit fund in 
existence on July 18, 1984, provides an individual in whose favor 
discrimination is prohibited with a post-retirement life insurance 
benefit after December 31, 1985, that does not meet the requirements of 
section 505(b) and if the welfare benefit fund received no contributions 
after July 18, 1984, then the disqualified benefit provided by the fund 
is not subject to section 4976(a)
    (b) A welfare benefit fund will be able to avoid the application of 
section 4976(b)(1) and (2) if the employer withdraws from such fund, 
before April 7, 1986, any amounts that are not attributable to 
``existing reserves for post-retirement medical or life insurance 
benefits'' because they were neither actually set aside nor treated as 
actually set aside under Q&A-4 of Sec. 1.512(a)-5T, on July 18, 1984. 
The employer making such a withdrawal must include the amount in income 
for the first taxable year ending after July 18, 1984, or, to the extent 
that the withdrawn amount is attributable to the following taxable year, 
for such following taxable year. Such a withdrawal will not be treated 
as an impermissible distribution or reversion under section 501(c)(9), 
and will not be treated as a disqualified benefit under section 
4976(b)(3). Of course, to the extent that the welfare benefit fund 
contains amounts that are attributable to ``existing reserves'' but are 
not within the transition rule set forth in Q&A-4 of Sec. 1.512(a)-5T 
(as applied to welfare benefit funds), for example, because such amounts 
exceed the amounts that could have been accumulated under the principles 
set forth in Revenue Rulings 69-382, 1969-2 C.B. 28; 69-478, 1969-2 C.B. 
29; and 73-599, 1973-2 C.B. 40, the fund will not be able to avoid the 
application of section 4976(b)(1) and (2) under this paragraph.
    (c) In the case of a plan which is maintained pursuant to one or 
more collective bargaining agreements (1) between employee 
representatives and one or more employers and (2) which are in effect on 
July 1, 1985 (or ratified on or before that date), the provision does 
not apply to disqualified benefits provided in years beginning before 
the termination of the last of the collective bargaining agreements 
pursuant to which the plan is maintained (determined without regard to 
any extension of the contract agreed to after July 1, 1985). For 
purposes of the preceding sentence, any plan amendment made pursuant to 
a collective bargaining agreement relating to the plan which amends the 
plan solely to conform to any requirement added under section

[[Page 299]]

511 of the Tax Reform Act 1984 (i.e., requirements under sections 419, 
419A, 512(a)(3)(E), and 4976) shall not be treated as a termination of 
such collective bargaining agreement.

[T.D. 8073, 51 FR 4336, Feb. 4, 1986]



Sec. 54.4977-1T  Questions and answers relating to the election 
concerning lines of business in existence on January 1, 1984 

(temporary).

    The following questions and answers relate to the election by 
employers under section 4977 of the Internal Revenue Code of 1954, as 
added by section 531(e)(1) of the Tax Reform Act of 1984 (98 Stat. 886), 
to treat all employees of any line of business in existence on January 
1, 1984, as employees of one of those lines of business for purposes of 
section 132(a) (1) and (2):
    Q-1: What does section 4977 provide with respect to the exclusion 
from gross income of certain fringe benefits?
    A-1: In general, section 4977 provides an elective grandfather rule 
that allows an employer under certain circumstances to treat employees 
of all lines of business which were in existence on January 1, 1984, as 
employees of one of those lines of business for purposes of section 
132(a) (1) and (2), but not for purposes of section 132(g)(2).
    Q-2: Under what circumstances does the elective grandfather rule of 
section 4977 apply?
    A-2: If:
    (a) An election under section 4977 is in effect with respect to an 
employer for any calendar year, and
    (b) On and after January 1, 1984, at least 85 percent of the 
employees of the employer in all of its lines of business which existed 
on January 1, 1984, were entitled to employee discounts or services 
provided by the employer in one line of business,

then all employees of any line of business of the employer which was in 
existence on January 1, 1984, are treated, for purposes of section 
132(a) (1) and (2) (but not for purposes of section 132(g)(2)) as 
employees of the one line of business referred to in (b) of this Q/A-2.
    Q-3: How does an employer make the election provided for in section 
4977?
    A-3: An employer must file a statement with the director of the 
service center with which the employer's tax returns are filed. The 
statement must indicate that the employer is electing to apply the 
provisions of section 4977 to one or more of the employer's lines of 
business and must contain the following information:
    (a) The employer's name, address, and taxpayer identification 
number;
    (b) A description of all of the employer's lines of business in 
existence on January 1, 1984; and
    (c) For each lines of business which is to have as an employee for 
purposes of section 132(a) (1) and (2) an individual but for the 
election under section 4977 would not be treated as an employee for 
purposes of section 132(a) (1) and (2):
    (1) A description of the no-additional-cost service or qualified 
employee discount (including, with respect to discounts, the percentage 
discount) to be offered to employees pursuant to section 4977 in such 
line of business, and
    (2) With respect to employees in all of the employer's lines of 
business in existence on January 1, 1984, the number of such employees 
and the number entitled to the described fringe benefit. Such numbers 
may be determined as of a date which does not precede the date the 
election is filed by more than 30 days.
    Q-4: In order to make a timely section 4977 election, when must an 
employer file the election statement?
    A-4: Except as otherwise provided in the second sentence of this 
answer, the employer must file the election statement before the end of 
the calendar year preceding the year for which the election is to apply. 
For calendar year 1985, however, the employer has until March 31, 1985, 
to file the election statement. However, the Commissioner may, in his 
discretion, extend the March 31, 1985 deadline to a later date.
    Q-5: Does section 4977 apply to all calendar years following the 
calendar year in which the election is made?
    A-5: Yes, unless the employer revokes the election.
    Q-6: When is a revocation effective?
    A-6: A revocation is effective with respect to the calendar year 
following the calendar year in which it is filed.

[[Page 300]]

    Q-7: If an employer does not make a timely section 4977 election 
with respect to 1985, will the employer be entitled to make an election 
with respect to any subsequent year?
    A-7: No.
    Q-8: If an employer revokes a section 4977 election, is the employer 
entitled to elect the application of section 4977 for subsequent years?
    A-8: No.

[T.D. 8004, 50 FR 758, Jan. 7, 1985]



Sec. 54.4978-1T  Questions and answers relating to the tax on certain 
dispositions by employee stock ownership plans and certain cooperatives

(temporary).

    Q-1: What does section 4978 provide?
    A-1: Section 4978 imposes a tax (as determined under section 4978(b) 
and Q&A-2 of this section) on the amount realized on the disposition of 
any qualified securities, if:
    (a) An employee stock ownership plan or eligible worker-owned 
cooperative acquires any qualified securities in a sale to which section 
1042 applies;
    (b) Such plan or cooperative disposes of any qualified securities 
during the 3-year period after the date on which any qualified 
securities were acquired in the sale to which section 1042 applies; and
    (c) Either (1) the percentage of the total outstanding shares of the 
class of employer securities of which the disposed qualified securities 
are a part held by such plan or cooperative after such disposition is 
less than the percentage of the total outstanding shares of such class 
of employer securities held immediately after the sale to which section 
1042 applies, or (2) the value of the employer securities held by such 
plan or cooperative immediately after such disposition is less than 30 
percent of the total value of all employer securities outstanding at 
that time. For purposes of this section, the following terms have the 
same meanings given to such terms by the identified provisions: 
``employee stock ownership plan'' (section 4975(e)(7)); ``qualified 
securities'' (section 1042(b)(1)); ``eligible worker-owned cooperative'' 
(section 1042(b)(2)); ``employer securities'' (section 409(l)). For 
purposes of determining what constitutes a disposition to which section 
4978 applies, see Q&A-3 of this section.
    Q-2: What is the amount of tax imposed under section 4978?
    A-2: Section 4978 imposes a tax of 10 percent of the amount realized 
on the disposition of qualified securities. The amount realized that is 
subject to tax under section 4978 shall not exceed that portion of the 
amount realized that is allocable to qualified securities acquired 
within the 3-year period prior to the date of disposition and to which 
section 1042 applied (``restricted qualified securities''). In 
determining the amount realized (except as otherwise provided in Q&A-3 
of this section), any disposition of employer securities with respect to 
which the condition contained in provision (c) of Q&A-1 is met shall be 
treated, first, as a disposition of restricted qualified securities (on 
a first in, first out basis) and, thereafter, as a disposition of any 
other employer securities. Thus, for example, if a plan disposes of more 
employer securities than the number of restricted qualified securities 
held by the plan at that time and immediately after such disposition the 
value of the employer securities held by the plan is less than 30 
percent of the total value of all outstanding employer securities, the 
portion of the total amount realized that is allocable to restricted 
qualified securities subject to tax under section 4978 is determined by 
multiplying the total amount realized on the disposition by a fraction, 
the numerator of which is the total value of restricted qualified 
securities included in the disposition and the denominator of which is 
the total value of employer securities in the disposition.
    Q-3: What constitutes a ``disposition'' under section 4978?
    A-3: (a) Under section 4978, the term ``disposition'' includes any 
sale, exchange, or distribution. However, in the case of any exchange of 
qualified securities for stock of another corporation in any 
reorganization described in section 368(a)(1), such exchange shall not 
be treated as a disposition for purposes of section 4978.
    (b) Section 4978 shall not apply to any disposition of qualified 
securites which is made by reason of:
    (1) The death of the employee;

[[Page 301]]

    (2) The retirement of the employee after the employee has attained 
59\1/2\ years of age;
    (3) The disability of the employee (within the meaning of section 
72(m)(5)); or
    (4) The separation of the employee from service for any period which 
results in a 1-year break in service (within the meaning of section 
411(a)(6)(A)).
    Any disposition of employer securities within this paragraph and any 
disposition of employer securities with respect to which the condition 
contained in provision (c) of Q&A-1 of this section is not met shall be 
treated, first, as a disposition of securities that are not restricted 
qualified securities and, thereafter, as a disposition of restricted 
qualified securities (on a first-in, first-out basis).
    (c) If restricted qualified securities held by an employee stock 
ownership plan or eligible worker-owned cooperative no longer meet the 
definition of qualified securities (``old restricted qualified 
securities'') as a result of a transaction changing (1) the status of a 
corporation as an employer, or as a member of a controlled group of 
corporations including the employer, or (2) the existence of employer 
securities of the type described in section 409(l)(1), the disposition 
of such securities shall not be treated as a disposition of restricted 
qualified securites to which the tax under section 4978 is imposed if, 
within 90 days after such disposition, securities meeting the 
requirements of section 409(l) (``new restricted qualified securities'') 
that are of equal value to the old restricted qualfied securities (at 
the time of the disposition of the old restricted qualified securities) 
are substituted for such old restricted qualified securities. However, 
for purposes of determining the tax imposed under section 4978, old 
restricted qualified securities shall not be treated as if they retained 
their status as restricted qualified securities and new restricted 
qualified securities derived from the disposition of old restricted 
qualified securities pursuant to the preceding sentence shall be treated 
as restricted qualified securities for the remaining portion of the 
period during which the disposition of the old restricted qualified 
securities would have been subject to tax under section 4978.
    Q-4: To whom does the tax under section 4978 apply?
    A-4: The tax under section 4978 is imposed on the domestic 
corporation (or corporations) or the eligible worker-owned cooperative 
that made the written statement of consent as described in section 
1042(a)(2)(B) and Q&A-2 of Sec. 1.1042-1T with respect to the 
disposition of the restricted qualified securities.
    Q-5: When does section 4978, as enacted by the Tax Reform Act of 
1984, become effective?
    A-5: Section 4978 applies to the disposition of qualified securities 
acquired in a sale to which section 1042 applies. See Q&A-6 of Sec. 
1.1042-1T for the effective date of section 1042.

[T.D. 8073, 51 FR 4336, Feb. 4, 1986]



Sec. 54.4979-0  Excise tax on certain excess contributions and excess 
aggregate contributions; table of contents.

    This section contains the captions that appear in Sec. 54.4979.

 Sec. 54.4979-1 Excise tax on certain excess contributions and excess 
                        aggregate contributions.

    (a) In general.
    (1) General rule.
    (2) Liability for tax.
    (3) Due date and form for payment of tax.
    (4) Special rule for simplified employee pensions.
    (b) Definitions.
    (1) Excess aggregate contributions.
    (2) Excess contributions.
    (3) Plan.
    (c) No tax when excess distributed within 2\1/2\ months of close of 
year or additional employer contributions made.
    (1) General rule.
    (2) Tax treatment of distributions.
    (3) Income.
    (4) Example.
    (d) Effective date.
    (1) General rule.
    (2) Section 403(b) annuity contracts.
    (3) Collectively bargained plans and plans of state or local 
governments.
    (4) Plan years beginning before January 1, 1992.

[T.D. 8357, 56 FR 40550, Aug. 15, 1991; 57 FR 10290, Mar. 25, 1992, as 
amended by T.D. 8581, 59 FR 66181, Dec. 23, 1994]

[[Page 302]]



Sec. 54.4979-1  Excise tax on certain excess contributions and excess
aggregate contributions.

    (a) In general--(1) General rule. In the case of any plan (as 
defined in paragraph (b)(3) of this section), there is imposed a tax for 
the employer's taxable year equal to 10 percent of the sum of:
    (i) Any excess contributions under a plan for the plan year ending 
in the taxable year; and
    (ii) Any excess aggregate contributions under the plan for the plan 
year ending in the taxable year.
    (2) Liability for tax. The tax imposed by paragraph (a)(1) of this 
section is to be paid by the employer. In the case of a collectively 
bargained plan to which section 413(b) applies, all employers who are 
parties to the collective bargaining agreement and whose employees are 
participants in the plan are jointly and severally liable for the tax.
    (3) Due date and form for payment of tax--(i) The tax described in 
paragraph (a)(1) of this section is due on the last day of the 15th 
month after the close of the plan year to which the excess contributions 
or excess aggregate contributions relate.
    (ii) An employer that owes the tax described in paragraph (a)(1) of 
this section must file the form prescribed by the Commissioner for the 
payment of the tax.
    (4) Special rule for simplified employee pensions--(i) An employer 
that maintains a simplified employee pension (SEP) as defined in section 
408(k) that accepts elective contributions is exempted from the tax of 
section 4979 and paragraph (a)(1) of this section if it notifies its 
employees of the fact and tax consequences of excess contributions 
within 2\1/2\ months following the plan year for which excess 
contributions are made. The notification must meet the standards of 
paragraph (a)(4)(ii) of this section.
    (ii) The employer's notification to each affected employee of the 
excess SEP contributions must specifically state, in a manner calculated 
to be understood by the average plan participant: the amount of the 
excess contributions attributable to that employee's elective deferrals; 
the calendar year for which the excess contributions were made; that the 
excess contributions are includible in the affected employee's gross 
income for the specified calendar year; and that failure to withdraw the 
excess contributions and income attributable thereto by the due date 
(plus extensions) for filing the affected employee's tax return for the 
preceding calendar year may result in significant penalties.
    (iii) If an employer does not notify its employees by the last day 
of the 12-month period following the year of excess SEP contributions, 
the SEP will no longer be considered to meet the requirements of section 
408(k)(6).
    (b) Definitions. The following is a list of terms and definitions to 
be used for purposes of section 4979 and this section:
    (1) Excess aggregate contributions. The term ``excess aggregate 
contribution'' has the meaning set forth in Sec. 1.401(m)-5 of this 
chapter. For purposes of determining excess aggregate contributions 
under an annuity contract described in section 403(b), the contract is 
treated as a plan described in section 401(a).
    (2) Excess contributions. The term ``excess contributions'' has the 
meaning set forth in sections 401(k)(8)(B), 408(k)(6)(C)(ii), and 
501(c)(18). See, e.g., Sec. 1.401(k)-6 of this chapter.
    (3) Plan. The term ``plan'' means:
    (i) A plan described in section 401(a) that includes a trust exempt 
from tax under section 501(a);
    (ii) Any annuity plan described in section 403(a);
    (iii) Any annuity contract described in section 403(b);
    (iv) A simplified employee pension of an employer that satisfies the 
requirements of section 408(k); and
    (v) A plan described in section 501(c)(18).

The term includes any plan that at any time has been determined by the 
Secretary to be one of the types of plans described in this paragraph 
(b)(3).
    (c) No tax when excess distributed within 2\1/2\ months of close of 
year or additional employer contributions made--(1) General rule. No tax 
is imposed under this section on any excess contribution or excess 
aggregate contribution, as the case may be, to the extent the 
contribution (together with any income allocable thereto) is corrected 
before the

[[Page 303]]

close of the first 2\1/2\ months of the following plan year (6 months in 
the case of a plan that includes an eligible automatic contribution 
arrangement within the meaning of section 414(w)). The extension to 6 
months applies to a distribution of excess contributions or excess 
aggregate contributions for a plan year beginning on or after January 1, 
2010, only where all the eligible NHCEs and eligible HCEs (both as 
defined in Sec. 1.401(k)-6 of this Chapter) are covered employees under 
an eligible automatic contribution arrangement within the meaning of 
section 414(w) for the entire plan year (or the portion of the plan year 
that the eligible NHCEs and eligible HCEs are eligible employees under 
the plan)). Qualified nonelective contributions and qualified matching 
contributions taken into account under Sec. 1.401(k)-2(a)(6) of this 
Chapter or qualified nonelective contributions or elective contributions 
taken into account under Sec. 1.401(m)-2(a)(6) of this Chapter for a 
plan year may permit a plan to avoid excess contributions or excess 
aggregate contributions, respectively, even if made after the close of 
the 2\1/2\ month (or 6 month) period for distributing excess 
contributions or excess aggregate contributions without the excise tax. 
See Sec. 1.401(k)-2(b)(1)(i) and (5)(i) of this Chapter for methods to 
avoid excess contributions, and Sec. 1.401(m)-2(b)(1)(i) of the Chapter 
for methods to avoid excess aggregate contributions.
    (2) Tax treatment of distributions. See Sec. 1.401(k)-2(b)(3)(ii) 
and (2)(vi) of this chapter for rules for determining the tax 
consequences to a participant of a distribution or recharacterization of 
excess contributions and income allocable thereto, including a special 
rule for de minimis distributions. See Sec. 1.401(m)-2(b)(2)(vi) of 
this chapter for rules for determining the tax consequences to a 
participant of a distribution of excess aggregate contributions and 
income allocable thereto.
    (3) Income. See Sec. 1.401(k)-2(b)(2)(iv) of this chapter for rules 
for determining income allocable to excess contributions. See Sec. 
1.401(m)-2(b)(2)(iv) of this chapter for rules for determining income 
allocable to excess aggregate contributions.
    (4) Example. The provisions of this paragraph (c) are illustrated by 
the following example.

    Example. (i) Employer X maintains Plan Y, a calendar year profit-
sharing plan that includes a qualified cash or deferred arrangement. 
Under the plan, failure to satisfy the actual deferral percentage test 
may only be corrected by distributing the excess contributions or making 
qualified nonelective contributions (QNECs).
    (ii) On December 31, 1990, X determines that Y does not satisfy the 
actual deferral percentage test for the 1990 plan year, and that excess 
contributions for the year equal $5,000. On March 1, 1991, Y distributes 
$2,000 of these excess contributions. On May 30, 1991, X distributes 
another $2,000 of excess contributions. On December 17, 1991, X 
contributes QNECs for certain nonhighly compensated employees, thereby 
eliminating the remainder of the excess contributions for 1990.
    (iii) X has incurred a tax liability under section 4979 for 1990 
equal to 10 percent of the excess contributions that were in the plan as 
of December 31, 1990. However, this tax is not imposed on the $2,000 
distributed on March 1, 1991, or the amount corrected by QNECs. X must 
pay an excise tax of $200, 10 percent of the $2,000 of excess 
contributions distributed after March 15, 1991. This tax must be paid by 
March 31, 1992.

    (d) Effective date--(1) General rule. Except as provided in 
paragraphs (d)(2) through (4), this section is effective for plan years 
beginning after December 31, 1986.
    (2) Section 403(b) annuity contracts. In the case of an annuity 
contract under section 403(b), this section applies to plan years 
beginning after December 31, 1988.
    (3) Collectively bargained plans and plans of state or local 
governments. For plan years beginning before January 1, 1993, the 
provisions of this section do not apply to a collectively bargained plan 
that automatically satisfies the requirements of section 410(b). See 
Sec. Sec. 1.401(a)(4)-1(c)(5) and 1.410(b)-2(b)(7) of this chapter. In 
the case of a plan (including a collectively bargained plan) maintained 
by a state or local government, the provisions of this section do not 
apply for plan years beginning before the later of January 1, 1996, or 
90 days after the opening of the first legislative session beginning on 
or after January 1, 1996, of the governing body with authority to amend 
the plan,

[[Page 304]]

if that body does not meet continuously. For purposes of this paragraph 
(d)(3), the term governing body with authority to amend the plan means 
the legislature, board, commission, council, or other governing body 
with authority to amend the plan.
    (4) Plan years beginning before January 1, 1992. For plan years 
beginning before January 1, 1992, a reasonable interpretation of the 
rules set forth in section 4979, as in effect during those years, may be 
relied upon in determining whether the excise tax is due for those 
years.

[T.D. 8357, 56 FR 40550, Aug. 15, 1991, as amended by T.D. 8581, 59 FR 
66181, Dec. 23, 1994; T.D. 9169, 69 FR 78153, Dec. 29, 2004; T.D. 9447, 
74 FR 8214, Feb. 24, 2009]

    Editorial Note: By T.D. 9169, 69 FR 78154, Dec. 29, 2005, Sec. 
54.4979-1 was amended in paragraph (c)(2); however, the amendment could 
not be incorporated due to inaccurate amendatory instruction.



Sec. 54.4980B-0  Table of contents.

    This section contains first a list of the section headings and then 
a list of the questions in each section in Sec. Sec. 54.4980B-1 through 
54.4980B-10.

                            List of Sections

Sec. 54.4980B-1 COBRA in general.
Sec. 54.4980B-2 Plans that must comply.
Sec. 54.4980B-3 Qualified beneficiaries.
Sec. 54.4980B-4 Qualifying events.
Sec. 54.4980B-5 COBRA continuation coverage.
Sec. 54.4980B-6 Electing COBRA continuation coverage.
Sec. 54.4980B-7 Duration of COBRA continuation coverage.
Sec. 54.4980B-8 Paying for COBRA continuation coverage.
Sec. 54.4980B-9 Business reorganizations and employer withdrawals from 
          multiemployer plans.
Sec. 54.4980B-10 Interaction of FMLA and COBRA.

                            List of Questions

Sec. 54.4980B-1 COBRA in general.

Q-1: What are the health care continuation coverage requirements 
          contained in section 4980B of the Internal Revenue Code and in 
          ERISA?
Q-2: What standard applies for topics not addressed in Sec. Sec. 
          54.4980B-1 through 54.4980B-10?

Sec. 54.4980B-2 Plans that must comply.

Q-1: For purposes of section 4980B, what is a group health plan?
Q-2: For purposes of section 4980B, what is the employer?
Q-3: What is a multiemployer plan?
Q-4: What group health plans are subject to COBRA?
Q-5: What is a small-employer plan?
Q-6: How is the number of group health plans that an employer or 
          employee organization maintains determined?
Q-7: What is the plan year?
Q-8: How do the COBRA continuation coverage requirements apply to 
          cafeteria plans and other flexible benefit arrangements?
Q-9: What is the effect of a group health plan's failure to comply with 
          the requirements of section 4980B(f)?
Q-10: Who is liable for the excise tax if a group health plan fails to 
          comply with the requirements of section 4980B(f)?
Q-11: If a person is liable for the excise tax under section 4980B, what 
          form must the person file and what is the due date for the 
          filing and payment of the excise tax?

Sec. 54.4980B-3 Qualified beneficiaries.

Q-1: Who is a qualified beneficiary?
Q-2: Who is an employee and who is a covered employee?
Q-3: Who are the similarly situated nonCOBRA beneficiaries?

Sec. 54.4980B-4 Qualifying events.

Q-1: What is a qualifying event?
Q-2: Are the facts surrounding a termination of employment (such as 
          whether it was voluntary or involuntary) relevant in 
          determining whether the termination of employment is a 
          qualifying event?

Sec. 54.4980B-5 COBRA continuation coverage.

Q-1: What is COBRA continuation coverage?
Q-2: What deductibles apply if COBRA continuation coverage is elected?
Q-3: How do a plan's limits apply to COBRA continuation coverage?
Q-4: Can a qualified beneficiary who elects COBRA continuation coverage 
          ever change from the coverage received by that individual 
          immediately before the qualifying event?
Q-5: Aside from open enrollment periods, can a qualified beneficiary who 
          has elected COBRA continuation coverage choose to cover 
          individuals (such as newborn children, adopted children, or 
          new spouses) who join the qualified beneficiary's family on or 
          after the date of the qualifying event?

Sec. 54.4980B-6 Electing COBRA continuation coverage.

Q-1: What is the election period and how long must it last?
Q-2: Is a covered employee or qualified beneficiary responsible for 
          informing the plan administrator of the occurrence of a 
          qualifying event?

[[Page 305]]

Q-3: During the election period and before the qualified beneficiary has 
          made an election, must coverage be provided?
Q-4: Is a waiver before the end of the election period effective to end 
          a qualified beneficiary's election rights?
Q-5: Can an employer or employee organization withhold money or other 
          benefits owed to a qualified beneficiary until the qualified 
          beneficiary either waives COBRA continuation coverage, elects 
          and pays for such coverage, or allows the election period to 
          expire?
Q-6: Can each qualified beneficiary make an independent election under 
          COBRA?

Sec. 54.4980B-7 Duration of COBRA continuation coverage.

Q-1: How long must COBRA continuation coverage be made available to a 
          qualified beneficiary?
Q-2: When may a plan terminate a qualified beneficiary's COBRA 
          continuation coverage due to coverage under another group 
          health plan?
Q-3: When may a plan terminate a qualified beneficiary's COBRA 
          continuation coverage due to the qualified beneficiary's 
          entitlement to Medicare benefits?
Q-4: When does the maximum coverage period end?
Q-5: How does a qualified beneficiary become entitled to a disability 
          extension?
Q-6: Under what circumstances can the maximum coverage period be 
          expanded?
Q-7: If health coverage is provided to a qualified beneficiary after a 
          qualifying event without regard to COBRA continuation coverage 
          (for example, as a result of state or local law, the Uniformed 
          Services Employment and Reemployment Rights Act of 1994 (38 
          U.S.C. 4315), industry practice, a collective bargaining 
          agreement, severance agreement, or plan procedure), will such 
          alternative coverage extend the maximum coverage period?
Q-8: Must a qualified beneficiary be given the right to enroll in a 
          conversion health plan at the end of the maximum coverage 
          period for COBRA continuation coverage?

Sec. 54.4980B-8 Paying for COBRA continuation coverage.

Q-1: Can a group health plan require payment for COBRA continuation 
          coverage?
Q-2: When is the applicable premium determined and when can a group 
          health plan increase the amount it requires to be paid for 
          COBRA continuation coverage?
Q-3: Must a plan allow payment for COBRA continuation coverage to be 
          made in monthly installments?
Q-4: Is a plan required to allow a qualified beneficiary to choose to 
          have the first payment for COBRA continuation coverage applied 
          prospectively only?
Q-5: What is timely payment for COBRA continuation coverage?

Sec. 54.4980B-9 Business reorganizations and employer withdrawals from 
          multiemployer plans.

Q-1: For purposes of this section, what are a business reorganization, a 
          stock sale, and an asset sale?
Q-2: In the case of a stock sale, what are the selling group, the 
          acquired organization, and the buying group?
Q-3: In the case of an asset sale, what are the selling group and the 
          buying group?
Q-4: Who is an M&A qualified beneficiary?
Q-5: In the case of a stock sale, is the sale a qualifying event with 
          respect to a covered employee who is employed by the acquired 
          organization before the sale and who continues to be employed 
          by the acquired organization after the sale, or with respect 
          to the spouse or dependent children of such a covered 
          employee?
Q-6: In the case of an asset sale, is the sale a qualifying event with 
          respect to a covered employee whose employment immediately 
          before the sale was associated with the purchased assets, or 
          with respect to the spouse or dependent children of such a 
          covered employee who are covered under a group health plan of 
          the selling group immediately before the sale?
Q-7: In a business reorganization, are the buying group and the selling 
          group permitted to allocate by contract the responsibility to 
          make COBRA continuation coverage available to M&A qualified 
          beneficiaries?
Q-8: Which group health plan has the obligation to make COBRA 
          continuation coverage available to M&A qualified beneficiaries 
          in a business reorganization?
Q-9: Can the cessation of contributions by an employer to a 
          multiemployer group health plan be a qualifying event?
Q-10: If an employer stops contributing to a multiemployer group health 
          plan, does the multiemployer plan have the obligation to make 
          COBRA continuation coverage available to a qualified 
          beneficiary who was receiving coverage under the multiemployer 
          plan on the day before the cessation of contributions and who 
          is, or whose qualifying event occurred in connection with, a 
          covered employee whose last employment prior to the qualifying 
          event was with the employer that has stopped contributing to 
          the multiemployer plan?

Sec. 54.4980B-10 Interaction of FMLA and COBRA.

Q-1: In what circumstances does a qualifying event occur if an employee 
          does not return from leave taken under FMLA?
Q-2: If a qualifying event described in Q&A-1 of this section occurs, 
          when does it

[[Page 306]]

          occur, and how is the maximum coverage period measured?
Q-3: If an employee fails to pay the employee portion of premiums for 
          coverage under a group health plan during FMLA leave or 
          declines coverage under a group health plan during FMLA leave, 
          does this affect the determination of whether or when the 
          employee has experienced a qualifying event?
Q-4: Is the application of the rules in Q&A-1 through Q&A-3 of this 
          section affected by a requirement of state or local law to 
          provide a period of coverage longer than that required under 
          FMLA?
Q-5: May COBRA continuation coverage be conditioned upon reimbursement 
          of the premiums paid by the employer for coverage under a 
          group health plan during FMLA leave?

[T.D. 8812, 64 FR 5173, Feb. 3, 1999, as amended by T.D. 8928, 66 FR 
1848, Jan. 10, 2001; T.D. 9457, 74 FR 45997, Sept. 8, 2009]



Sec. 54.4980B-1  COBRA in general.

    The COBRA continuation coverage requirements are described in 
general in the following questions-and-answers:
    Q-1: What are the health care continuation coverage requirements 
contained in section 4980B of the Internal Revenue Code and in ERISA?
    A-1: (a) Section 4980B provides generally that a group health plan 
must offer each qualified beneficiary who would otherwise lose coverage 
under the plan as a result of a qualifying event an opportunity to 
elect, within the election period, continuation coverage under the plan. 
The continuation coverage requirements were added to section 162 by the 
Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA), Public 
Law 99-272 (100 Stat. 222), and moved to section 4980B by the Technical 
and Miscellaneous Revenue Act of 1988, Public Law 100-647 (102 Stat. 
3342). Continuation coverage required under section 4980B is referred to 
in Sec. Sec. 54.4980B-1 through 54.4980B-10 as COBRA continuation 
coverage.
    (b) COBRA also added parallel continuation coverage requirements to 
Part 6 of Subtitle B of Title I of the Employee Retirement Income 
Security Act of 1974 (ERISA) (29 U.S.C. 1161-1168), which is 
administered by the U.S. Department of Labor. If a plan does not comply 
with the COBRA continuation coverage requirements, the Internal Revenue 
Code imposes an excise tax on the employer maintaining the plan (or on 
the plan itself), whereas ERISA gives certain parties--including 
qualified beneficiaries who are participants or beneficiaries within the 
meaning of Title I of ERISA, as well as the Department of Labor--the 
right to file a lawsuit to redress the noncompliance. The rules in 
Sec. Sec. 54.4980B-1 through 54.4980B-10 apply for purposes of section 
4980B and generally also for purposes of the COBRA continuation coverage 
requirements in Title I of ERISA. However, certain provisions of the 
COBRA continuation coverage requirements (such as the definitions of 
group health plan, employee, and employer) are not identical in the 
Internal Revenue Code and Title I of ERISA. In those cases in which the 
statutory language is not identical, the rules in Sec. Sec. 54.4980B-1 
through 54.4980B-10 nonetheless apply to the COBRA continuation coverage 
requirements of Title I of ERISA, except to the extent those rules are 
inconsistent with the statutory language of Title I of ERISA.
    (c) A group health plan that is subject to section 4980B (or the 
parallel provisions under ERISA) is referred to as being subject to 
COBRA. (See Q&A-4 of Sec. 54.4980B-2). A qualified beneficiary can be 
required to pay for COBRA continuation coverage. The term qualified 
beneficiary is defined in Q&A-1 of Sec. 54.4980B-3. The term qualifying 
event is defined in Q&A-1 of Sec. 54.4980B-4. COBRA continuation 
coverage is described in Sec. 54.4980B-5. The election procedures are 
described in Sec. 54.4980B-6. Duration of COBRA continuation coverage 
is addressed in Sec. 54.4980B-7, and payment for COBRA continuation 
coverage is addressed in Sec. 54.4980B-8. Section 54.4980B-9 contains 
special rules for how COBRA applies in connection with business 
reorganizations and employer withdrawals from a multiemployer plan, and 
Sec. 54.4980B-10 addresses how COBRA applies for individuals who take 
leave under the Family and Medical Leave Act of 1993. Unless the context 
indicates otherwise, any reference in Sec. Sec. 54.4980B-1 through 
54.4980B-10 to COBRA refers to section 4980B (as amended) and to the 
parallel provisions of ERISA.

[[Page 307]]

    Q-2: What standard applies for topics not addressed in Sec. Sec. 
54.4980B-1 through 54.4980B-10?
    A-2: For purposes of section 4980B, for topics relating to the COBRA 
continuation coverage requirements of section 4980B that are not 
addressed in Sec. Sec. 54.4980B-1 through 54.4980B-10 (such as methods 
for calculating the applicable premium), plans and employers must 
operate in good faith compliance with a reasonable interpretation of the 
statutory requirements in section 4980B.

[T.D. 8812, 64 FR 5173, Feb 3, 1999; 64 FR 14382, Mar. 25, 1999, as 
amended by T.D. 8928, 66 FR 1849, Jan. 10, 2001]



Sec. 54.4980B-2  Plans that must comply.

    The following questions-and-answers apply in determining which plans 
must comply with the COBRA continuation coverage requirements:
    Q-1: For purposes of section 4980B, what is a group health plan?
    A-1: (a) For purposes of section 4980B, a group health plan is a 
plan maintained by an employer or employee organization to provide 
health care to individuals who have an employment-related connection to 
the employer or employee organization or to their families. Individuals 
who have an employment-related connection to the employer or employee 
organization consist of employees, former employees, the employer, and 
others associated or formerly associated with the employer or employee 
organization in a business relationship (including members of a union 
who are not currently employees). Health care is provided under a plan 
whether provided directly or through insurance, reimbursement, or 
otherwise, and whether or not provided through an on-site facility 
(except as set forth in paragraph (d) of this Q&A-1), or through a 
cafeteria plan (as defined in section 125) or other flexible benefit 
arrangement. (See paragraphs (b) through (e) in Q&A-8 of this section 
for rules regarding the application of the COBRA continuation coverage 
requirements to certain health flexible spending arrangements.) For 
purposes of this Q&A-1, insurance includes not only group insurance 
policies but also one or more individual insurance policies in any 
arrangement that involves the provision of health care to two or more 
employees. A plan maintained by an employer or employee organization is 
any plan of, or contributed to (directly or indirectly) by, an employer 
or employee organization. Thus, a group health plan is maintained by an 
employer or employee organization even if the employer or employee 
organization does not contribute to it if coverage under the plan would 
not be available at the same cost to an individual but for the 
individual's employment-related connection to the employer or employee 
organization. These rules are further explained in paragraphs (b) 
through (d) of this Q&A-1. An exception for qualified long-term care 
services is set forth in paragraph (e) of this Q&A-1, and for medical 
savings accounts in paragraph (f) of this Q&A-1. See Q&A-6 of this 
section for rules to determine the number of group health plans that an 
employer or employee organization maintains.
    (b) For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10, 
health care has the same meaning as medical care under section 213(d). 
Thus, health care generally includes the diagnosis, cure, mitigation, 
treatment, or prevention of disease, and any other undertaking for the 
purpose of affecting any structure or function of the body. Health care 
also includes transportation primarily for and essential to health care 
as described in the preceding sentence. However, health care does not 
include anything that is merely beneficial to the general health of an 
individual, such as a vacation. Thus, if an employer or employee 
organization maintains a program that furthers general good health, but 
the program does not relate to the relief or alleviation of health or 
medical problems and is generally accessible to and used by employees 
without regard to their physical condition or state of health, that 
program is not considered a program that provides health care and so is 
not a group health plan. For example, if an employer maintains a spa, 
swimming pool, gymnasium, or other exercise/fitness program or facility 
that is normally accessible to and used by employees for reasons other 
than relief of health or medical problems, such a facility does not 
constitute a program

[[Page 308]]

that provides health care and thus is not a group health plan. In 
contrast, if an employer maintains a drug or alcohol treatment program 
or a health clinic, or any other facility or program that is intended to 
relieve or alleviate a physical condition or health problem, the 
facility or program is considered to be the provision of health care and 
so is considered a group health plan.
    (c) Whether a benefit provided to employees constitutes health care 
is not affected by whether the benefit is excludable from income under 
section 132 (relating to certain fringe benefits). For example, if a 
department store provides its employees discounted prices on all 
merchandise, including health care items such as drugs or eyeglasses, 
the mere fact that the discounted prices also apply to health care items 
will not cause the program to be a plan providing health care, so long 
as the discount program would normally be accessible to and used by 
employees without regard to health needs or physical condition. If, 
however, the employer maintaining the discount program is a health 
clinic, so that the program is used exclusively by employees with health 
or medical needs, the program is considered to be a plan providing 
health care and so is considered to be a group health plan.
    (d) The provision of health care at a facility that is located on 
the premises of an employer or employee organization does not constitute 
a group health plan if--
    (1) The health care consists primarily of first aid that is provided 
during the employer's working hours for treatment of a health condition, 
illness, or injury that occurs during those working hours;
    (2) The health care is available only to current employees; and
    (3) Employees are not charged for the use of the facility.
    (e) A plan does not constitute a group health plan subject to COBRA 
if substantially all of the coverage provided under the plan is for 
qualified long-term care services (as defined in section 7702B(c)). For 
this purpose, a plan is permitted to use any reasonable method in 
determining whether substantially all of the coverage provided under the 
plan is for qualified long-term care services.
    (f) Under section 106(b)(5), amounts contributed by an employer to a 
medical savings account (as defined in section 220(d)) are not 
considered part of a group health plan subject to COBRA. Thus, a plan is 
not required to make COBRA continuation coverage available with respect 
to amounts contributed by an employer to a medical savings account. A 
high deductible health plan does not fail to be a group health plan 
subject to COBRA merely because it covers a medical savings account 
holder.
    Q-2: For purposes of section 4980B, what is the employer?
    A-2: (a) For purposes of section 4980B, employer refers to--
    (1) A person for whom services are performed;
    (2) Any other person that is a member of a group described in 
section 414(b), (c), (m), or (o) that includes a person described in 
paragraph (a)(1) of this Q&A-2 and
    (3) Any successor of a person described in paragraph (a)(1) or (2) 
of this Q&A-2.
    (b) An employer is a successor employer if it results from a 
consolidation, merger, or similar restructuring of the employer or if it 
is a mere continuation of the employer. See paragraph (c) in Q&A-8 of 
Sec. 54.4980B-9 for rules describing the circumstances in which a 
purchaser of substantial assets is a successor employer to the employer 
selling the assets.
    Q-3: What is a multiemployer plan?
    A-3: For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10, a 
multiemployer plan is a plan to which more than one employer is required 
to contribute, that is maintained pursuant to one or more collective 
bargaining agreements between one or more employee organizations and 
more than one employer, and that satisfies such other requirements as 
the Secretary of Labor may prescribe by regulation. Whenever reference 
is made in Sec. Sec. 54.4980B-1 through 54.4980B-10 to a plan of or 
maintained by an employer or employee organization, the reference 
includes a multiemployer plan.
    Q-4: What group health plans are subject to COBRA?

[[Page 309]]

    A-4: (a) All group health plans are subject to COBRA except group 
health plans described in paragraph (b) of this Q&A-4. Group health 
plans described in paragraph (b) of this Q&A-4 are referred to in 
Sec. Sec. 54.4980B-1 through 54.4980B-10 as excepted from COBRA.
    (b) The following group health plans are excepted from COBRA--
    (1) Small-employer plans (see Q&A-5 of this section);
    (2) Church plans (within the meaning of section 414(e)); and
    (3) Governmental plans (within the meaning of section 414(d)).
    (c) The COBRA continuation coverage requirements generally do not 
apply to group health plans that are excepted from COBRA. However, a 
small-employer plan otherwise excepted from COBRA is nonetheless subject 
to COBRA with respect to qualified beneficiaries who experience a 
qualifying event during a period when the plan is not a small-employer 
plan (see paragraph (g) of Q&A-5 of this section).
    (d) Although governmental plans are not subject to the COBRA 
continuation coverage requirements, group health plans maintained by 
state or local governments are generally subject to parallel 
continuation coverage requirements that were added by section 10003 of 
COBRA to the Public Health Service Act (42 U.S.C. 300bb-1 through 300bb-
8), which is administered by the U.S. Department of Health and Human 
Services. Federal employees and their family members covered under the 
Federal Employees Health Benefit Program are covered by generally 
similar, but not parallel, temporary continuation of coverage provisions 
enacted by the Federal Employees Health Benefits Amendments Act of 1988. 
See 5 U.S.C. 8905a.
    Q-5: What is a small-employer plan?
    A-5: (a) Except in the case of a multiemployer plan, a small-
employer plan is a group health plan maintained by an employer (within 
the meaning of Q&A-2 of this section) that normally employed fewer than 
20 employees (within the meaning of paragraph (c) of this Q&A-5) during 
the preceding calendar year. In the case of a multiemployer plan, a 
small-employer plan is a group health plan under which each of the 
employers contributing to the plan for a calendar year normally employed 
fewer than 20 employees during the preceding calendar year. See Q&A-6 of 
this section for rules to determine the number of plans that an employer 
or employee organization maintains. The rules of this paragraph (a) are 
illustrated in the following example:

    Example. (i) Corporation S employs 12 employees, all of whom work 
and reside in the United States. S maintains a group health plan for its 
employees and their families. S is a wholly-owned subsidiary of P. In 
the previous calendar year, the controlled group of corporations 
including P and S employed more than 19 employees, although the only 
employees in the United States of the controlled group that includes P 
and S are the 12 employees of S.
    (ii) Under Sec. 1.414(b)-1 of this chapter, foreign corporations 
are not excluded from membership in a controlled group of corporations. 
Consequently, the group health plan maintained by S is not a small-
employer plan during the current calendar year because the controlled 
group including S normally employed at least 20 employees in the 
preceding calendar year.

    (b) An employer is considered to have normally employed fewer than 
20 employees during a particular calendar year if, and only if, it had 
fewer than 20 employees on at least 50 percent of its typical business 
days during that year.
    (c) All full-time and part-time common law employees of an employer 
are taken into account in determining whether an employer had fewer than 
20 employees; however, an individual who is not a common law employee of 
the employer is not taken into account. Thus, the following individuals 
are not counted as employees for purposes of this Q&A-5 even though they 
are referred to as employees for all other purposes of Sec. Sec. 
54.4980B-1 through 54.4980B-10--
    (1) Self-employed individuals (within the meaning of section 
401(c)(1));
    (2) Independent contractors (and their employees and independent 
contractors); and
    (3) Directors (in the case of a corporation).
    (d) In determining the number of the employees of an employer, each 
full-time employee is counted as one employee and each part-time 
employee is counted as a fraction of an employee,

[[Page 310]]

determined in accordance with paragraph (e) of this Q&A-5.
    (e) An employer may determine the number of its employees on a daily 
basis or a pay period basis. The basis used by the employer must be used 
with respect to all employees of the employer and must be used for the 
entire year for which the number of employees is being determined. If an 
employer determines the number of its employees on a daily basis, it 
must determine the actual number of full-time employees on each typical 
business day and the actual number of part-time employees and the hours 
worked by each of those part-time employees on each typical business 
day. Each full-time employee counts as one employee on each typical 
business day and each part-time employee counts as a fraction, with the 
numerator of the fraction equal to the number of hours worked by that 
employee and the denominator equal to the number of hours that must be 
worked on a typical business day in order to be considered a full-time 
employee. If an employer determines the number of its employees on a pay 
period basis, it must determine the actual number of full-time employees 
employed during that pay period and the actual number of part-time 
employees employed and the hours worked by each of those part-time 
employees during the pay period. For each day of that pay period, each 
full-time employee counts as one employee and each part-time employee 
counts as a fraction, with the numerator of the fraction equal to the 
number of hours worked by that employee during that pay period and the 
denominator equal to the number of hours that must be worked during that 
pay period in order to be considered a full-time employee. The 
determination of the number of hours required to be considered a full-
time employee is based upon the employer's employment practices, except 
that in no event may the hours required to be considered a full-time 
employee exceed eight hours for any day or 40 hours for any week.
    (f) In the case of a multiemployer plan, the determination of 
whether the plan is a small-employer plan on any particular date depends 
on which employers are contributing to the plan on that date and on the 
workforce of those employers during the preceding calendar year. If a 
plan that is otherwise subject to COBRA ceases to be a small-employer 
plan because of the addition during a calendar year of an employer that 
did not normally employ fewer than 20 employees on a typical business 
day during the preceding calendar year, the plan ceases to be excepted 
from COBRA immediately upon the addition of the new employer. In 
contrast, if the plan ceases to be a small-employer plan by reason of an 
increase during a calendar year in the workforce of an employer 
contributing to the plan, the plan ceases to be excepted from COBRA on 
the January 1 immediately following the calendar year in which the 
employer's workforce increased.
    (g) A small-employer plan is generally excepted from COBRA. If, 
however, a plan that has been subject to COBRA (that is, was not a 
small-employer plan) becomes a small-employer plan, the plan remains 
subject to COBRA for qualifying events that occurred during the period 
when the plan was subject to COBRA. The rules of this paragraph (g) are 
illustrated by the following examples:

    Example 1. An employer maintains a group health plan. The employer 
employed 20 employees on more than 50 percent of its working days during 
2001, and consequently the plan is not excepted from COBRA during 2002. 
Employee E resigns and does not work for the employer after January 31, 
2002. Under the terms of the plan, E is no longer eligible for coverage 
upon the effective date of the resignation, that is, February 1, 2002. 
The employer does not hire a replacement for E. E timely elects and pays 
for COBRA continuation coverage. The employer employs 19 employees for 
the remainder of 2002, and consequently the plan is not subject to COBRA 
in 2003. The plan must nevertheless continue to make COBRA continuation 
coverage available to E during 2003 until the obligation to make COBRA 
continuation coverage available ceases under the rules of Sec. 
54.4980B-7. The obligation could continue until August 1, 2003, the date 
that is 18 months after the date of E's qualifying event, or longer if E 
is eligible for a disability extension.
    Example 2. The facts are the same as in Example 1. The employer 
continues to employ 19 employees throughout 2003 and 2004 and 
consequently the plan continues to be excepted from COBRA during 2004 
and 2005.

[[Page 311]]

Spouse S is covered under the plan because S is married to one of the 
employer's employees. On April 1, 2002, S is divorced from that employee 
and ceases to be eligible for coverage under the plan. The plan is 
subject to COBRA during 2002 because X normally employed 20 employees 
during 2001. S timely notifies the plan administrator of the divorce and 
timely elects and pays for COBRA continuation coverage. Even though the 
plan is generally excepted from COBRA during 2003, 2004, and 2005, it 
must nevertheless continue to make COBRA continuation coverage available 
to S during those years until the obligation to make COBRA continuation 
coverage available ceases under the rules of Sec. 54.4980B-7. The 
obligation could continue until April 1, 2005, the date that is 36 
months after the date of S's qualifying event.
    Example 3. The facts are the same as in Example 2. C is a dependent 
child of one of the employer's employees and is covered under the plan. 
A dependent child is no longer eligible for coverage under the plan upon 
the attainment of age 23. C attains age 23 on November 16, 2005. The 
plan is excepted from COBRA with respect to C during 2005 because the 
employer normally employed fewer than 20 employees during 2004. 
Consequently, the plan is not obligated to make COBRA continuation 
coverage available to C (and would not be obligated to make COBRA 
continuation coverage available to C even if the plan later became 
subject to COBRA again).

    Q-6: How is the number of group health plans that an employer or 
employee organization maintains determined?
    A-6: (a) The rules of this Q&A-6 apply in determining the number of 
group health plans that an employer or employee organization maintains. 
All references elsewhere in Sec. Sec. 54.4980B-1 through 54.4980B-10 to 
a group health plan are references to a group health plan as determined 
under Q&A-1 of this section and this Q&A-6. Except as provided in 
paragraph (b) or (c) of this Q&A-6, all health care benefits, other than 
benefits for qualified long-term care services (as defined in section 
7702B(c)), provided by a corporation, partnership, or other entity or 
trade or business, or by an employee organization, constitute one group 
health plan, unless--
    (1) It is clear from the instruments governing an arrangement or 
arrangements to provide health care benefits that the benefits are being 
provided under separate plans; and
    (2) The arrangement or arrangements are operated pursuant to such 
instruments as separate plans.
    (b) A multiemployer plan and a nonmultiemployer plan are always 
separate plans.
    (c) If a principal purpose of establishing separate plans is to 
evade any requirement of law, then the separate plans will be considered 
a single plan to the extent necessary to prevent the evasion.
    (d) The significance of treating an arrangement as two or more 
separate group health plans is illustrated by the following examples:

    Example 1. (i) Employer X maintains a single group health plan, 
which provides major medical and prescription drug benefits. Employer Y 
maintains two group health plans; one provides major medical benefits 
and the other provides prescription drug benefits.
    (ii) X's plan could comply with the COBRA continuation coverage 
requirements by giving a qualified beneficiary experiencing a qualifying 
event with respect to X's plan the choice of either electing both major 
medical and prescription drug benefits or not receiving any COBRA 
continuation coverage under X's plan. By contrast, for Y's plans to 
comply with the COBRA continuation coverage requirements, a qualified 
beneficiary experiencing a qualifying event with respect to each of Y's 
plans must be given the choice of electing COBRA continuation coverage 
under either the major medical plan or the prescription drug plan or 
both.
    Example 2. If a joint board of trustees administers one 
multiemployer plan, that plan will fail to qualify for the small-
employer plan exception if any one of the employers whose employees are 
covered under the plan normally employed 20 or more employees during the 
preceding calendar year. However, if the joint board of trustees 
maintains two or more multiemployer plans, then the exception would be 
available with respect to each of those plans in which each of the 
employers whose employees are covered under the plan normally employed 
fewer than 20 employees during the preceding calendar year.

    Q-7: What is the plan year?
    A-7: (a) The plan year is the year that is designated as the plan 
year in the plan documents.
    (b) If the plan documents do not designate a plan year (or if there 
are no plan documents), then the plan year is determined in accordance 
with this paragraph (b).

[[Page 312]]

    (1) The plan year is the deductible/limit year used under the plan.
    (2) If the plan does not impose deductibles or limits on an annual 
basis, then the plan year is the policy year.
    (3) If the plan does not impose deductibles or limits on an annual 
basis, and either the plan is not insured or the insurance policy is not 
renewed on an annual basis, then the plan year is the employer's taxable 
year.
    (4) In any other case, the plan year is the calendar year.
    Q-8: How do the COBRA continuation coverage requirements apply to 
cafeteria plans and other flexible benefit arrangements?
    A-8: (a)(1) The provision of health care benefits does not fail to 
be a group health plan merely because those benefits are offered under a 
cafeteria plan (as defined in section 125) or under any other 
arrangement under which an employee is offered a choice between health 
care benefits and other taxable or nontaxable benefits. However, the 
COBRA continuation coverage requirements apply only to the type and 
level of coverage under the cafeteria plan or other flexible benefit 
arrangement that a qualified beneficiary is actually receiving on the 
day before the qualifying event. See paragraphs (b) through (e) of this 
Q&A-8 for rules limiting the obligations of certain health flexible 
spending arrangements.
    (2) The rules of this paragraph (a) are illustrated by the following 
example:

    Example: (i) Under the terms of a cafeteria plan, employees can 
choose among life insurance coverage, membership in a health maintenance 
organization (HMO), coverage for medical expenses under an indemnity 
arrangement, and cash compensation. Of these available choices, the HMO 
and the indemnity arrangement are the arrangements providing health 
care. The instruments governing the HMO and indemnity arrangements 
indicate that they are separate group health plans. These group health 
plans are subject to COBRA. The employer does not provide any group 
health plan outside of the cafeteria plan. B and C are unmarried 
employees. B has chosen the life insurance coverage, and C has chosen 
the indemnity arrangement.
    (ii) B does not have to be offered COBRA continuation coverage upon 
terminating employment, nor is a subsequent open enrollment period for 
active employees required to be made available to B. However, if C 
terminates employment and the termination constitutes a qualifying 
event, C must be offered an opportunity to elect COBRA continuation 
coverage under the indemnity arrangement. If C makes such an election 
and an open enrollment period for active employees occurs while C is 
still receiving the COBRA continuation coverage, C must be offered the 
opportunity to switch from the indemnity arrangement to the HMO (but not 
to the life insurance coverage because that does not constitute coverage 
provided under a group health plan).

    (b) If a health flexible spending arrangement (health FSA), within 
the meaning of section 106(c)(2), satisfies the two conditions in 
paragraph (c) of this Q&A-8 for a plan year, the obligation of the 
health FSA to make COBRA continuation coverage available to a qualified 
beneficiary who experiences a qualifying event in that plan year is 
limited in accordance with paragraphs (d) and (e) of this Q&A-8, as 
illustrated by an example in paragraph (f) of this Q&A-8. To the extent 
that a health FSA is obligated to make COBRA continuation coverage 
available to a qualified beneficiary, the health FSA must comply with 
all the applicable rules of Sec. Sec. 54.4980B-1 through 54.4980B-10, 
including the rules of Q&A-3 in Sec. 54.4980B-5 (relating to limits).
    (c) The conditions of this paragraph (c) are satisfied if--
    (1) Benefits provided under the health FSA are excepted benefits 
within the meaning of sections 9831 and 9832; and
    (2) The maximum amount that the health FSA can require to be paid 
for a year of COBRA continuation coverage under Q&A-1 of Sec. 54.4980B-
8 equals or exceeds the maximum benefit available under the health FSA 
for the year.
    (d) If the conditions in paragraph (c) of this Q&A-8 are satisfied 
for a plan year, then the health FSA is not obligated to make COBRA 
continuation coverage available for any subsequent plan year to any 
qualified beneficiary who experiences a qualifying event during that 
plan year.
    (e) If the conditions in paragraph (c) of this Q&A-8 are satisfied 
for a plan year, the health FSA is not obligated to make COBRA 
continuation coverage available for that plan year to any qualified 
beneficiary who experiences a qualifying event during that plan year

[[Page 313]]

unless, as of the date of the qualifying event, the qualified 
beneficiary can become entitled to receive during the remainder of the 
plan year a benefit that exceeds the maximum amount that the health FSA 
is permitted to require to be paid for COBRA continuation coverage for 
the remainder of the plan year. In determining the amount of the benefit 
that a qualified beneficiary can become entitled to receive during the 
remainder of the plan year, the health FSA may deduct from the maximum 
benefit available to that qualified beneficiary for the year (based on 
the election made under the health FSA for that qualified beneficiary 
before the date of the qualifying event) any reimbursable claims 
submitted to the health FSA for that plan year before the date of the 
qualifying event.
    (f) The rules of paragraphs (b), (c), (d), and (e) of this Q&A-8 are 
illustrated by the following example:

    Example. (i) An employer maintains a group health plan providing 
major medical benefits and a group health plan that is a health FSA, and 
the plan year for each plan is the calendar year. Both the plan 
providing major medical benefits and the health FSA are subject to 
COBRA. Under the health FSA, during an open season before the beginning 
of each calendar year, employees can elect to reduce their compensation 
during the upcoming year by up to $1200 per year and have that same 
amount contributed to a health flexible spending account. The employer 
contributes an additional amount to the account equal to the employee's 
salary reduction election for the year. Thus, the maximum amount 
available to an employee under the health FSA for a year is two times 
the amount of the employee's salary reduction election for the year. 
This amount may be paid to the employee during the year as reimbursement 
for health expenses not covered by the employer's major medical plan 
(such as deductibles, copayments, prescription drugs, or eyeglasses). 
The employer determined, in accordance with section 4980B(f)(4), that a 
reasonable estimate of the cost of providing coverage for similarly 
situated nonCOBRA beneficiaries for 2002 under this health FSA is equal 
to two times their salary reduction election for 2002 and, thus, that 
two times the salary reduction election is the applicable premium for 
2002.
    (ii) Because the employer provides major medical benefits under 
another group health plan, and because the maximum benefit that any 
employee can receive under the health FSA is not greater than two times 
the employee's salary reduction election for the plan year, benefits 
under this health FSA are excepted benefits within the meaning of 
sections 9831 and 9832. Thus, the first condition of paragraph (c) of 
this Q&A-8 is satisfied for the year. The maximum amount that a plan can 
require to be paid for coverage (outside of coverage required to be made 
available due to a disability extension) under Q&A-1 of Sec. 54.4980B-8 
is 102 percent of the applicable premium. Thus, the maximum amount that 
the health FSA can require to be paid for coverage for the 2002 plan 
year is 2.04 times the employee's salary reduction election for the plan 
year. Because the maximum benefit available under the health FSA is 2.0 
times the employee's salary reduction election for the year, the maximum 
benefit available under the health FSA for the year is less than the 
maximum amount that the health FSA can require to be paid for coverage 
for the year. Thus, the second condition in paragraph (c) of this Q&A-8 
is also satisfied for the 2002 plan year. Because both conditions in 
paragraph (c) of this Q&A-8 are satisfied for 2002, with respect to any 
qualifying event occurring in 2002, the health FSA is not obligated to 
make COBRA continuation coverage available for any year after 2002.
    (iii) Whether the health FSA is obligated to make COBRA continuation 
coverage available in 2002 to a qualified beneficiary with respect to a 
qualifying event that occurs in 2002 depends upon the maximum benefit 
that would be available to the qualified beneficiary under COBRA 
continuation coverage for that plan year. Case 1: Employee B has elected 
to reduce B's salary by $1200 for 2002. Thus, the maximum benefit that B 
can become entitled to receive under the health FSA during the entire 
year is $2400. B experiences a qualifying event that is the termination 
of B's employment on May 31, 2002. As of that date, B had submitted $300 
of reimbursable expenses under the health FSA. Thus, the maximum benefit 
that B could become entitled to receive for the remainder of 2002 is 
$2100. The maximum amount that the health FSA can require to be paid for 
COBRA continuation coverage for the remainder of 2002 is 102 percent 
times 1/12 of the applicable premium for 2002 times the number of months 
remaining in 2002 after the date of the qualifying event. In B's case, 
the maximum amount that the health FSA can require to be paid for COBRA 
continuation coverage for 2002 is 2.04 times $1200, or $2448. One-
twelfth of $2448 is $204. Because seven months remain in the plan year, 
the maximum amount that the health FSA can require to be paid for B's 
coverage for the remainder of the year is seven times $204, or $1428. 
Because $1428 is less than the maximum benefit that B could become 
entitled to receive for the remainder of the year ($2100), the health 
FSA is required to make COBRA continuation coverage available to B

[[Page 314]]

for the remainder of 2002 (but not for any subsequent year).
    (iv) Case 2: The facts are the same as in Case 1 except that B had 
submitted $1000 of reimbursable expenses as of the date of the 
qualifying event. In that case, the maximum benefit available to B for 
the remainder of the year would be $1400 instead of $2100. Because the 
maximum amount that the health FSA can require to be paid for B's 
coverage is $1428, and because the $1400 maximum benefit for the 
remainder of the year does not exceed $1428, the health FSA is not 
obligated to make COBRA continuation coverage available to B in 2002 (or 
any later year). (Of course, the administrator of the health FSA is 
permitted to make COBRA continuation coverage available to every 
qualified beneficiary in the year that the qualified beneficiary's 
qualifying event occurs in order to avoid having to determine the 
maximum benefit available for each qualified beneficiary for the 
remainder of the plan year.)

    Q-9: What is the effect of a group health plan's failure to comply 
with the requirements of section 4980B(f)?
    A-9: Under section 4980B(a), if a group health plan subject to COBRA 
fails to comply with section 4980B(f), an excise tax is imposed. 
Moreover, non-tax remedies may be available if the plan fails to comply 
with the parallel requirements in ERISA, which are administered by the 
Department of Labor.
    Q-10: Who is liable for the excise tax if a group health plan fails 
to comply with the requirements of section 4980B(f)?
    A-10: (a) In general, the excise tax is imposed on the employer 
maintaining the plan, except that in the case of a multiemployer plan 
(see Q&A-3 of this section for a definition of multiemployer plan) the 
excise tax is imposed on the plan.
    (b) In certain circumstances, the excise tax is also imposed on a 
person involved with the provision of benefits under the plan (other 
than in the capacity of an employee), such as an insurer providing 
benefits under the plan or a third party administrator administering 
claims under the plan. In general, such a person will be liable for the 
excise tax if the person assumes, under a legally enforceable written 
agreement, the responsibility for performing the act to which the 
failure to comply with the COBRA continuation coverage requirements 
relates. Such a person will be liable for the excise tax notwithstanding 
the absence of a written agreement assuming responsibility for complying 
with COBRA if the person provides coverage under the plan to a similarly 
situated nonCOBRA beneficiary (see Q&A-3 of Sec. 54.4980B-3 for a 
definition of similarly situated nonCOBRA beneficiaries) and the 
employer or plan administrator submits a written request to the person 
to provide to a qualified beneficiary the same coverage that the person 
provides to the similarly situated nonCOBRA beneficiary. If the person 
providing coverage under the plan to a similarly situated nonCOBRA 
beneficiary is the plan administrator and the qualifying event is a 
divorce or legal separation or a dependent child's ceasing to be covered 
under the generally applicable requirements of the plan, the plan 
administrator will also be liable for the excise tax if the qualified 
beneficiary submits a written request for coverage.
    Q-11: If a person is liable for the excise tax under section 4980B, 
what form must the person file and what is the due date for the filing 
and payment of the excise tax?
    A-11: (a) In general. See Sec. Sec. 54.6011-2 and 54.6151-1.
    (b) Due date for filing of return by employers or other persons 
responsible for benefits under a group health plan. See Sec. 54.6071-
1(a)(1).
    (c) Due date for filing of return by multiemployer plans. See Sec. 
54.6071-1(a)(2).
    (d) Effective/applicability date. In the case of an employer or 
other person mentioned in paragraph (b) of this Q & A-11, the rules in 
this Q & A-11 are effective for taxable years beginning on or after 
January 1, 2010. In the case of a plan mentioned in paragraph (c) of 
this Q & A-11, the rules in this Q & A-11 are effective for plan years 
beginning on or after January 1, 2010.

[T.D. 8812, 64 FR 5174, Feb. 3, 1999, as amended by T.D. 8928, 66 FR 
1849, Jan. 10, 2001; T.D. 9457, 74 FR 45997, Sept. 8, 2009]



Sec. 54.4980B-3  Qualified beneficiaries.

    The determination of who is a qualified beneficiary, an employee, or 
a covered employee, and of who are the similarly situated nonCOBRA 
beneficiaries is addressed in the following questions-and-answers:

[[Page 315]]

    Q-1: Who is a qualified beneficiary?
    A-1: (a)(1) Except as set forth in paragraphs (c) through (f) of 
this Q&A-1, a qualified beneficiary is--
    (i) Any individual who, on the day before a qualifying event, is 
covered under a group health plan by virtue of being on that day either 
a covered employee, the spouse of a covered employee, or a dependent 
child of the covered employee; or
    (ii) Any child who is born to or placed for adoption with a covered 
employee during a period of COBRA continuation coverage.
    (2) In the case of a qualifying event that is the bankruptcy of the 
employer, a covered employee who had retired on or before the date of 
substantial elimination of group health plan coverage is also a 
qualified beneficiary, as is any spouse, surviving spouse, or dependent 
child of such a covered employee if, on the day before the bankruptcy 
qualifying event, the spouse, surviving spouse, or dependent child is a 
beneficiary under the plan.
    (3) In general, an individual (other than a child who is born to or 
placed for adoption with a covered employee during a period of COBRA 
continuation coverage) who is not covered under a plan on the day before 
the qualifying event cannot be a qualified beneficiary with respect to 
that qualifying event, and the reason for the individual's lack of 
actual coverage (such as the individual's having declined participation 
in the plan or failed to satisfy the plan's conditions for 
participation) is not relevant for this purpose. However, if the 
individual is denied or not offered coverage under a plan under 
circumstances in which the denial or failure to offer constitutes a 
violation of applicable law (such as the Americans with Disabilities 
Act, 42 U.S.C. 12101-12213, the special enrollment rules of section 
9801, or the requirements of section 9802 prohibiting discrimination in 
eligibility to enroll in a group health plan based on health status), 
then, for purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10, the 
individual will be considered to have had the coverage that was 
wrongfully denied or not offered.
    (4) Paragraph (b) of this Q&A-1 describes how certain family members 
are not qualified beneficiaries even if they become covered under the 
plan; paragraphs (c), (d), and (e) of this Q&A-1 place limits on the 
general rules of this paragraph (a) concerning who is a qualified 
beneficiary; paragraph (f) of this Q&A-1 provides when an individual who 
has been a qualified beneficiary ceases to be a qualified beneficiary; 
paragraph (g) of this Q&A-1 defines placed for adoption; and paragraph 
(h) of this Q&A-1 contains examples.
    (b) In contrast to a child who is born to or placed for adoption 
with a covered employee during a period of COBRA continuation coverage, 
an individual who marries any qualified beneficiary on or after the date 
of the qualifying event and a newborn or adopted child (other than one 
born to or placed for adoption with a covered employee) are not 
qualified beneficiaries by virtue of the marriage, birth, or placement 
for adoption or by virtue of the individual's status as the spouse or 
the child's status as a dependent of the qualified beneficiary. These 
new family members do not themselves become qualified beneficiaries even 
if they become covered under the plan. (For situations in which a plan 
is required to make coverage available to new family members of a 
qualified beneficiary who is receiving COBRA continuation coverage, see 
Q&A-5 of Sec. 54.4980B-5, paragraph (c) in Q&A-4 of Sec. 54.4980B-5, 
and section 9801(f)(2).)
    (c) An individual is not a qualified beneficiary if, on the day 
before the qualifying event referred to in paragraph (a) of this Q&A-1, 
the individual is covered under the group health plan by reason of 
another individual's election of COBRA continuation coverage and is not 
already a qualified beneficiary by reason of a prior qualifying event.
    (d) A covered employee can be a qualified beneficiary only in 
connection with a qualifying event that is the termination, or reduction 
of hours, of the covered employee's employment, or that is the 
bankruptcy of the employer.
    (e) An individual is not a qualified beneficiary if the individual's 
status as a covered employee is attributable to a period in which the 
individual was a nonresident alien who received from

[[Page 316]]

the individual's employer no earned income (within the meaning of 
section 911(d)(2)) that constituted income from sources within the 
United States (within the meaning of section 861(a)(3)). If, pursuant to 
the preceding sentence, an individual is not a qualified beneficiary, 
then a spouse or dependent child of the individual is not considered a 
qualified beneficiary by virtue of the relationship to the individual.
    (f) A qualified beneficiary who does not elect COBRA continuation 
coverage in connection with a qualifying event ceases to be a qualified 
beneficiary at the end of the election period (see Q&A-1 of Sec. 
54.4980B-6). Thus, for example, if such a former qualified beneficiary 
is later added to a covered employee's coverage (e.g., during an open 
enrollment period) and then another qualifying event occurs with respect 
to the covered employee, the former qualified beneficiary does not 
become a qualified beneficiary by reason of the second qualifying event. 
If a covered employee who is a qualified beneficiary does not elect 
COBRA continuation coverage during the election period, then any child 
born to or placed for adoption with the covered employee on or after the 
date of the qualifying event is not a qualified beneficiary. Once a 
plan's obligation to make COBRA continuation coverage available to an 
individual who has been a qualified beneficiary ceases under the rules 
of Sec. 54.4980B-7, the individual ceases to be a qualified 
beneficiary.
    (g) For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10, 
placement for adoption or being placed for adoption means the assumption 
and retention by the covered employee of a legal obligation for total or 
partial support of a child in anticipation of the adoption of the child. 
The child's placement for adoption with the covered employee terminates 
upon the termination of the legal obligation for total or partial 
support. A child who is immediately adopted by the covered employee 
without a preceding placement for adoption is considered to be placed 
for adoption on the date of the adoption.
    (h) The rules of this Q&A-1 are illustrated by the following 
examples:

    Example 1. (i) B is a single employee who voluntarily terminates 
employment and elects COBRA continuation coverage under a group health 
plan. To comply with the requirements of section 9801(f), the plan 
permits a covered employee who marries to have her or his spouse covered 
under the plan. One month after electing COBRA continuation coverage, B 
marries and chooses to have B's spouse covered under the plan.
    (ii) B's spouse is not a qualified beneficiary. Thus, if B dies 
during the period of COBRA continuation coverage, the plan does not have 
to offer B's surviving spouse an opportunity to elect COBRA continuation 
coverage.
    Example 2. (i) C is a married employee who terminates employment. C 
elects COBRA continuation coverage for C but not C's spouse, and C's 
spouse declines to elect such coverage. C's spouse thus ceases to be a 
qualified beneficiary. At the next open enrollment period, C adds the 
spouse as a beneficiary under the plan.
    (ii) The addition of the spouse during the open enrollment period 
does not make the spouse a qualified beneficiary. The plan thus will not 
have to offer the spouse an opportunity to elect COBRA continuation 
coverage upon a later divorce from or death of C.
    Example 3. (i) Under the terms of a group health plan, a covered 
employee's child, upon attaining age 19, ceases to be a dependent 
eligible for coverage.
    (ii) At that time, the child must be offered an opportunity to elect 
COBRA continuation coverage. If the child elects COBRA continuation 
coverage, the child marries during the period of the COBRA continuation 
coverage, and the child's spouse becomes covered under the group health 
plan, the child's spouse is not a qualified beneficiary.
    Example 4. (i) D is a single employee who, upon retirement, is given 
the opportunity to elect COBRA continuation coverage but declines it in 
favor of an alternative offer of 12 months of employer-paid retiree 
health benefits. At the end of the election period, D ceases to be a 
qualified beneficiary and will not have to be given another opportunity 
to elect COBRA continuation coverage (at the end of those 12 months or 
at any other time). D marries E during the period of retiree health 
coverage and, under the terms of that coverage, E becomes covered under 
the plan.
    (ii) If a divorce from or death of D will result in E's losing 
coverage, E will be a qualified beneficiary because E's coverage under 
the plan on the day before the qualifying event (that is, the divorce or 
death) will have been by reason of D's acceptance of 12 months of 
employer-paid coverage after the prior qualifying event (D's retirement) 
rather than by reason of an election of COBRA continuation coverage.
    Example 5. (i) The facts are the same as in Example 4, except that, 
under the terms of the plan, the divorce or death does not cause

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E to lose coverage so that E continues to be covered for the balance of 
the original 12-month period.
    (ii) E does not have to be allowed to elect COBRA continuation 
coverage because the loss of coverage at the end of the 12-month period 
is not caused by the divorce or death, and thus the divorce or death 
does not constitute a qualifying event. See Q&A-1 of Sec. 54.4980B-4.

    Q-2: Who is an employee and who is a covered employee?
    A-2: (a)(1) For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-
10 (except for purposes of Q&A-5 in Sec. 54.4980B-2, relating to the 
exception from COBRA for plans maintained by an employer with fewer than 
20 employees), an employee is any individual who is eligible to be 
covered under a group health plan by virtue of the performance of 
services for the employer maintaining the plan or by virtue of 
membership in the employee organization maintaining the plan. Thus, for 
purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10 (except for 
purposes of Q&A-5 in Sec. 54.4980B-2), the following individuals are 
employees if their relationship to the employer maintaining the plan 
makes them eligible to be covered under the plan--
    (i) Self-employed individuals (within the meaning of section 
401(c)(1));
    (ii) Independent contractors (and their employees and independent 
contractors); and
    (iii) Directors (in the case of a corporation).
    (2) Similarly, whenever reference is made in Sec. Sec. 54.4980B-1 
through 54.4980B-10 (except in Q&A-5 of Sec. 54.4980B-2) to an 
employment relationship (such as by referring to the termination of 
employment of an employee or to an employee's being employed by an 
employer), the reference includes the relationship of those individuals 
who are employees within the meaning of this paragraph (a). See 
paragraph (c) in Q&A-5 of Sec. 54.4980B-2 for a narrower meaning of 
employee solely for purposes of Q&A-5 of Sec. 54.4980B-2.
    (b) For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10, a 
covered employee is any individual who is (or was) provided coverage 
under a group health plan (other than a plan that is excepted from COBRA 
on the date of the qualifying event; see Q&A-4 of Sec. 54.4980B-2) by 
virtue of being or having been an employee. For example, a retiree or 
former employee who is covered by a group health plan is a covered 
employee if the coverage results in whole or in part from her or his 
previous employment. An employee (or former employee) who is merely 
eligible for coverage under a group health plan is generally not a 
covered employee if the employee (or former employee) is not actually 
covered under the plan. In general, the reason for the employee's (or 
former employee's) lack of actual coverage (such as having declined 
participation in the plan or having failed to satisfy the plan's 
conditions for participation) is not relevant for this purpose. However, 
if the employee (or former employee) is denied or not offered coverage 
under circumstances in which the denial or failure to offer constitutes 
a violation of applicable law (such as the Americans with Disabilities 
Act, 42 U.S.C. 12101 through 12213, the special enrollment rules of 
section 9801, or the requirements of section 9802 prohibiting 
discrimination in eligibility to enroll in a group health plan based on 
health status), then, for purposes of Sec. Sec. 54.4980B-1 through 
54.4980B-10, the employee (or former employee) will be considered to 
have had the coverage that was wrongfully denied or not offered.
    Q-3: Who are the similarly situated nonCOBRA beneficiaries?
    A-3: For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10, 
similarly situated nonCOBRA beneficiaries means the group of covered 
employees, spouses of covered employees, or dependent children of 
covered employees receiving coverage under a group health plan 
maintained by the employer or employee organization who are receiving 
that coverage for a reason other than the rights provided under the 
COBRA continuation coverage requirements and who, based on all of the 
facts and circumstances, are most similarly situated to the situation of 
the qualified beneficiary immediately before the qualifying event.

[T.D. 8812, 64 FR 5176, Feb. 3, 1999, as amended by T.D. 8928, 66 FR 
1852, Jan. 10, 2001]

[[Page 318]]



Sec. 54.4980B-4  Qualifying events.

    The determination of what constitutes a qualifying event is 
addressed in the following questions and answers:
    Q-1: What is a qualifying event?
    A-1: (a) A qualifying event is an event that satisfies paragraphs 
(b), (c), and (d) of this Q&A-1. Paragraph (e) of this Q&A-1 further 
explains a reduction of hours of employment, paragraph (f) of this Q&A-1 
describes the treatment of children born to or placed for adoption with 
a covered employee during a period of COBRA continuation coverage, and 
paragraph (g) of this Q&A-1 contains examples. See Q&A-1 through Q&A-3 
of Sec. 54.4980B-10 for special rules in the case of leave taken under 
the Family and Medical Leave Act of 1993 (29 U.S.C. 2601-2619).
    (b) An event satisfies this paragraph (b) if the event is any of the 
following--
    (1) The death of a covered employee;
    (2) The termination (other than by reason of the employee's gross 
misconduct), or reduction of hours, of a covered employee's employment;
    (3) The divorce or legal separation of a covered employee from the 
employee's spouse;
    (4) A covered employee's becoming entitled to Medicare benefits 
under Title XVIII of the Social Security Act (42 U.S.C. 1395-1395ggg);
    (5) A dependent child's ceasing to be a dependent child of a covered 
employee under the generally applicable requirements of the plan; or
    (6) A proceeding in bankruptcy under Title 11 of the United States 
Code with respect to an employer from whose employment a covered 
employee retired at any time.
    (c) An event satisfies this paragraph (c) if, under the terms of the 
group health plan, the event causes the covered employee, or the spouse 
or a dependent child of the covered employee, to lose coverage under the 
plan. For this purpose, to lose coverage means to cease to be covered 
under the same terms and conditions as in effect immediately before the 
qualifying event. Any increase in the premium or contribution that must 
be paid by a covered employee (or the spouse or dependent child of a 
covered employee) for coverage under a group health plan that results 
from the occurrence of one of the events listed in paragraph (b) of this 
Q&A-1 is a loss of coverage. In the case of an event that is the 
bankruptcy of the employer, lose coverage also means any substantial 
elimination of coverage under the plan, occurring within 12 months 
before or after the date the bankruptcy proceeding commences, for a 
covered employee who had retired on or before the date of the 
substantial elimination of group health plan coverage or for any spouse, 
surviving spouse, or dependent child of such a covered employee if, on 
the day before the bankruptcy qualifying event, the spouse, surviving 
spouse, or dependent child is a beneficiary under the plan. For purposes 
of this paragraph (c), a loss of coverage need not occur immediately 
after the event, so long as the loss of coverage occurs before the end 
of the maximum coverage period (see Q&A-4 and Q&A-6 of Sec. 54.4980B-
7). However, if neither the covered employee nor the spouse or a 
dependent child of the covered employee loses coverage before the end of 
what would be the maximum coverage period, the event does not satisfy 
this paragraph (c). If coverage is reduced or eliminated in anticipation 
of an event (for example, an employer's eliminating an employee's 
coverage in anticipation of the termination of the employee's 
employment, or an employee's eliminating the coverage of the employee's 
spouse in anticipation of a divorce or legal separation), the reduction 
or elimination is disregarded in determining whether the event causes a 
loss of coverage.
    (d) An event satisfies this paragraph (d) if it occurs while the 
plan is subject to COBRA. Thus, an event will not satisfy this paragraph 
(d) if it occurs while the plan is excepted from COBRA (see Q&A-4 of 
Sec. 54.4980B-2). Even if the plan later becomes subject to COBRA, it 
is not required to make COBRA continuation coverage available to anyone 
whose coverage ends as a result of an event during a year in which the 
plan is excepted from COBRA. For example, if a group health plan is 
excepted from COBRA as a small-employer plan during the year 2001 (see 
Q&A-5 of Sec. 54.4980B-2) and an employee terminates employment on 
December 31,

[[Page 319]]

2001, the termination is not a qualifying event and the plan is not 
required to permit the employee to elect COBRA continuation coverage. 
This is the case even if the plan ceases to be a small-employer plan as 
of January 1, 2002. Also, the same result will follow even if the 
employee is given three months of coverage beyond December 31 (that is, 
through March of 2002), because there will be no qualifying event as of 
the termination of coverage in March. However, if the employee's spouse 
is initially provided with the three-month coverage through March 2002, 
but the spouse divorces the employee before the end of the three months 
and loses coverage as a result of the divorce, the divorce will 
constitute a qualifying event during 2002 and so entitle the spouse to 
elect COBRA continuation coverage. See Q&A-7 of Sec. 54.4980B-7 
regarding the maximum coverage period in such a case.
    (e) A reduction of hours of a covered employee's employment occurs 
whenever there is a decrease in the hours that a covered employee is 
required to work or actually works, but only if the decrease is not 
accompanied by an immediate termination of employment. This is true 
regardless of whether the covered employee continues to perform services 
following the reduction of hours of employment. For example, an absence 
from work due to disability, a temporary layoff, or any other reason 
(other than due to leave that is FMLA leave; see Sec. 54.4980B-10) is a 
reduction of hours of a covered employee's employment if there is not an 
immediate termination of employment. If a group health plan measures 
eligibility for the coverage of employees by the number of hours worked 
in a given time period, such as the preceding month or quarter, and an 
employee covered under the plan fails to work the minimum number of 
hours during that time period, the failure to work the minimum number of 
required hours is a reduction of hours of that covered employee's 
employment.
    (f) The qualifying event of a qualified beneficiary who is a child 
born to or placed for adoption with a covered employee during a period 
of COBRA continuation coverage is the qualifying event giving rise to 
the period of COBRA continuation coverage during which the child is born 
or placed for adoption. If a second qualifying event has occurred before 
the child is born or placed for adoption (such as the death of the 
covered employee), then the second qualifying event also applies to the 
newborn or adopted child. See Q&A-6 of Sec. 54.4980B-7.
    (g) The rules of this Q&A-1 are illustrated by the following 
examples, in each of which the group health plan is subject to COBRA:

    Example 1. (i) An employee who is covered by a group health plan 
terminates employment (other than by reason of the employee's gross 
misconduct) and, beginning with the day after the last day of 
employment, is given 3 months of employer-paid coverage under the same 
terms and conditions as before that date. At the end of the three 
months, the coverage terminates.
    (ii) The loss of coverage at the end of the three months results 
from the termination of employment and, thus, the termination of 
employment is a qualifying event.
    Example 2. (i) An employee who is covered by a group health plan 
retires (which is a termination of employment other than by reason of 
the employee's gross misconduct) and, upon retirement, is required to 
pay an increased amount for the same group health coverage that the 
employee had before retirement.
    (ii) The increase in the premium or contribution required for 
coverage is a loss of coverage under paragraph (c) of this Q&A-1 and, 
thus, the retirement is a qualifying event.
    Example 3. (i) An employee and the employee's spouse are covered 
under an employer's group health plan. The employee retires and is given 
identical coverage for life. However, the plan provides that the spousal 
coverage will not be continued beyond six months unless a higher premium 
for the spouse is paid to the plan.
    (ii) The requirement for the spouse to pay a higher premium at the 
end of the six months is a loss of coverage under paragraph (c) of this 
Q&A-1. Thus, the retirement is a qualifying event and the spouse must be 
given an opportunity to elect COBRA continuation coverage.
    Example 4. (i) F is a covered employee who is married to G, and both 
are covered under a group health plan maintained by F's employer. F and 
G are divorced. Under the terms of the plan, the divorce causes G to 
lose coverage. The divorce is a qualifying event, and G elects COBRA 
continuation coverage, remarries during the period of COBRA continuation 
coverage, and G's new spouse

[[Page 320]]

becomes covered under the plan. (See Q&A-5 in Sec. 54.4980B-5, 
paragraph (c) in Q&A-4 of Sec. 54.4980B-5, and section 9801(f)(2).) G 
dies. Under the terms of the plan, the death causes G's new spouse to 
lose coverage under the plan.
    (ii) G's death is not a qualifying event because G is not a covered 
employee.
    Example 5. (i) An employer maintains a group health plan for both 
active employees and retired employees (and their families). The 
coverage for active employees and retired employees is identical, and 
the employer does not require retirees to pay more for coverage than 
active employees. The plan does not make COBRA continuation coverage 
available when an employee retires (and is not required to because the 
retired employee has not lost coverage under the plan). The employer 
amends the plan to eliminate coverage for retired employees effective 
January 1, 2002. On that date, several retired employees (and their 
spouses and dependent children) have been covered under the plan since 
their retirement for less than the maximum coverage period that would 
apply to them in connection with their retirement.
    (ii) The elimination of retiree coverage under these circumstances 
is a deferred loss of coverage for those retirees (and their spouses and 
dependent children) under paragraph (c) of this Q&A-1 and, thus, the 
retirement is a qualifying event. The plan must make COBRA continuation 
coverage available to them for the balance of the maximum coverage 
period that applies to them in connection with the retirement.

    Q-2: Are the facts surrounding a termination of employment (such as 
whether it was voluntary or involuntary) relevant in determining whether 
the termination of employment is a qualifying event?
    A-2: Apart from facts constituting gross misconduct, the facts 
surrounding the termination or reduction of hours are irrelevant in 
determining whether a qualifying event has occurred. Thus, it does not 
matter whether the employee voluntarily terminated or was discharged. 
For example, a strike or a lockout is a termination or reduction of 
hours that constitutes a qualifying event if the strike or lockout 
results in a loss of coverage as described in paragraph (c) of Q&A-1 of 
this section. Similarly, a layoff that results in such a loss of 
coverage is a qualifying event.

[T.D. 8812, 64 FR 5178, Feb. 3, 1999, as amended by T.D. 8928, 66 FR 
1852, Jan. 10, 2001]



Sec. 54.4980B-5  COBRA continuation coverage.

    The following questions-and-answers address the requirements for 
coverage to constitute COBRA continuation coverage:
    Q-1: What is COBRA continuation coverage?
    A-1: (a) If a qualifying event occurs, each qualified beneficiary 
(other than a qualified beneficiary for whom the qualifying event will 
not result in any immediate or deferred loss of coverage) must be 
offered an opportunity to elect to receive the group health plan 
coverage that is provided to similarly situated nonCOBRA beneficiaries 
(ordinarily, the same coverage that the qualified beneficiary had on the 
day before the qualifying event). See Q&A-3 of Sec. 54.4980B-3 for the 
definition of similarly situated nonCOBRA beneficiaries. This coverage 
is COBRA continuation coverage. If coverage is modified for similarly 
situated nonCOBRA beneficiaries, then the coverage made available to 
qualified beneficiaries is modified in the same way. If the continuation 
coverage offered differs in any way from the coverage made available to 
similarly situated nonCOBRA beneficiaries, the coverage offered does not 
constitute COBRA continuation coverage and the group health plan is not 
in compliance with COBRA unless other coverage that does constitute 
COBRA continuation coverage is also offered. Any elimination or 
reduction of coverage in anticipation of an event described in paragraph 
(b) of Q&A-1 of Sec. 54.4980B-4 is disregarded for purposes of this 
Q&A-1 and for purposes of any other reference in Sec. Sec. 54.4980B-1 
through 54.4980B-10 to coverage in effect immediately before (or on the 
day before) a qualifying event. COBRA continuation coverage must not be 
conditioned upon, or discriminate on the basis of lack of, evidence of 
insurability.
    (b) In the case of a qualified beneficiary who is a child born to or 
placed for adoption with a covered employee during a period of COBRA 
continuation coverage, the child is generally entitled to elect 
immediately to have the same coverage that dependent children of active 
employees receive under the benefit packages under which the covered 
employee has coverage at the time

[[Page 321]]

of the birth or placement for adoption. Such a child would be entitled 
to elect coverage different from that elected by the covered employee 
during the next available open enrollment period under the plan. See 
Q&A-4 of this section.
    Q-2: What deductibles apply if COBRA continuation coverage is 
elected?
    A-2: (a) Qualified beneficiaries electing COBRA continuation 
coverage generally are subject to the same deductibles as similarly 
situated nonCOBRA beneficiaries. If a qualified beneficiary's COBRA 
continuation coverage begins before the end of a period prescribed for 
accumulating amounts toward deductibles, the qualified beneficiary must 
retain credit for expenses incurred toward those deductibles before the 
beginning of COBRA continuation coverage as though the qualifying event 
had not occurred. The specific application of this rule depends on the 
type of deductible, as set forth in paragraphs (b) through (d) of this 
Q&A-2. Special rules are set forth in paragraph (e) of this Q&A-2, and 
examples appear in paragraph (f) of this Q&A-2.
    (b) If a deductible is computed separately for each individual 
receiving coverage under the plan, each individual's remaining 
deductible amount (if any) on the date COBRA continuation coverage 
begins is equal to that individual's remaining deductible amount 
immediately before that date.
    (c) If a deductible is computed on a family basis, the remaining 
deductible for the family on the date that COBRA continuation coverage 
begins depends on the members of the family electing COBRA continuation 
coverage. In computing the family deductible that remains on the date 
COBRA continuation coverage begins, only the expenses of those family 
members receiving COBRA continuation coverage need be taken into 
account. If the qualifying event results in there being more than one 
family unit (for example, because of a divorce), the family deductible 
may be computed separately for each resulting family unit based on the 
members in each unit. These rules apply regardless of whether the plan 
provides that the family deductible is an alternative to individual 
deductibles or an additional requirement.
    (d) Deductibles that are not described in paragraph (b) or (c) of 
this Q&A-2 must be treated in a manner consistent with the principles 
set forth in those paragraphs.
    (e) If a deductible is computed on the basis of a covered employee's 
compensation instead of being a fixed dollar amount and the employee 
remains employed during the period of COBRA continuation coverage, the 
plan is permitted to choose whether to apply the deductible by treating 
the employee's compensation as continuing without change for the 
duration of the COBRA continuation coverage at the level that was used 
to compute the deductible in effect immediately before the COBRA 
continuation coverage began, or to apply the deductible by taking the 
employee's actual compensation into account. In applying a deductible 
that is computed on the basis of the covered employee's compensation 
instead of being a fixed dollar amount, for periods of COBRA 
continuation coverage in which the employee is not employed by the 
employer, the plan is required to compute the deductible by treating the 
employee's compensation as continuing without change for the duration of 
the COBRA continuation coverage either at the level that was used to 
compute the deductible in effect immediately before the COBRA 
continuation coverage began or at the level that was used to compute the 
deductible in effect immediately before the employee's employment was 
terminated.
    (f) The rules of this Q&A-2 are illustrated by the following 
examples; in each example, deductibles under the plan are determined on 
a calendar year basis:

    Example 1. (i) A group health plan applies a separate $100 annual 
deductible to each individual it covers. The plan provides that the 
spouse and dependent children of a covered employee will lose coverage 
on the last day of the month after the month of the covered employee's 
death. A covered employee dies on June 11, 2001. The spouse and the two 
dependent children elect COBRA continuation coverage, which will begin 
on August 1, 2001. As of July 31, 2001, the spouse has incurred $80 of 
covered expenses, the older child has

[[Page 322]]

incurred no covered expenses, and the younger one has incurred $120 of 
covered expenses (and therefore has already satisfied the deductible).
    (ii) At the beginning of COBRA continuation coverage on August 1, 
the spouse has a remaining deductible of $20, the older child still has 
the full $100 deductible, and the younger one has no further deductible.
    Example 2. (i) A group health plan applies a separate $200 annual 
deductible to each individual it covers, except that each family member 
is treated as having satisfied the individual deductible once the family 
has incurred $500 of covered expenses during the year. The plan provides 
that upon the divorce of a covered employee, coverage will end 
immediately for the employee's spouse and any children who do not remain 
in the employee's custody. A covered employee with four dependent 
children is divorced, the spouse obtains custody of the two oldest 
children, and the spouse and those children all elect COBRA continuation 
coverage to begin immediately. The family had accumulated $420 of 
covered expenses before the divorce, as follows: $70 by each parent, 
$200 by the oldest child, $80 by the youngest child, and none by the 
other two children.
    (ii) The resulting family consisting of the spouse and the two 
oldest children accumulated a total of $270 of covered expenses, and 
thus the remaining deductible for that family could be as high as $230 
(because the plan would not have to count the incurred expenses of the 
covered employee and the youngest child). The remaining deductible for 
the resulting family consisting of the covered employee and the two 
youngest children is not subject to the rules of this Q&A-2 because 
their coverage is not COBRA continuation coverage.
    Example 3. Each year a group health plan pays 70 percent of the cost 
of an individual's psychotherapy after that individual's first three 
visits during the year. A qualified beneficiary whose election of COBRA 
continuation coverage takes effect beginning August 1, 2001 and who has 
already made two visits as of that date need only pay for one more visit 
before the plan must begin to pay 70 percent of the cost of the 
remaining visits during 2001.
    Example 4. (i) A group health plan has a $250 annual deductible per 
covered individual. The plan provides that if the deductible is not 
satisfied in a particular year, expenses incurred during October through 
December of that year are credited toward satisfaction of the deductible 
in the next year. A qualified beneficiary who has incurred covered 
expenses of $150 from January through September of 2001 and $40 during 
October elects COBRA continuation coverage beginning November 1, 2001.
    (ii) The remaining deductible amount for this qualified beneficiary 
is $60 at the beginning of the COBRA continuation coverage. If this 
individual incurs covered expenses of $50 in November and December of 
2001 combined (so that the $250 deductible for 2001 is not satisfied), 
the $90 incurred from October through December of 2001 are credited 
toward satisfaction of the deductible amount for 2002.

    Q-3: How do a plan's limits apply to COBRA continuation coverage?
    A-3: (a) Limits are treated in the same way as deductibles (see Q&A-
2 of this section). This rule applies both to limits on plan benefits 
(such as a maximum number of hospital days or dollar amount of 
reimbursable expenses) and limits on out-of-pocket expenses (such as a 
limit on copayments, a limit on deductibles plus copayments, or a 
catastrophic limit). This rule applies equally to annual and lifetime 
limits and applies equally to limits on specific benefits and limits on 
benefits in the aggregate under the plan.
    (b) The rule of this Q&A-3 is illustrated by the following examples; 
in each example limits are determined on a calendar year basis:

    Example 1. (i) A group health plan pays for a maximum of 150 days of 
hospital confinement per individual per year. A covered employee who has 
had 20 days of hospital confinement as of May 1, 2001 terminates 
employment and elects COBRA continuation coverage as of that date.
    (ii) During the remainder of the year 2001 the plan need only pay 
for a maximum of 130 days of hospital confinement for this individual.
    Example 2. (i) A group health plan reimburses a maximum of $20,000 
of covered expenses per family per year, and the same $20,000 limit 
applies to unmarried covered employees. A covered employee and spouse 
who have no children divorce on May 1, 2001, and the spouse elects COBRA 
continuation coverage as of that date. In 2001, the employee had 
incurred $5,000 of expenses and the spouse had incurred $8,000 before 
May 1.
    (ii) The plan can limit its reimbursement of the amount of expenses 
incurred by the spouse on and after May 1 for the remainder of the year 
to $12,000 ($20,000-$8,000 = $12,000). The remaining limit for the 
employee is not subject to the rules of this Q&A-3 because the 
employee's coverage is not COBRA continuation coverage.
    Example 3. (i) A group health plan pays for 80 percent of covered 
expenses after satisfaction of a $100-per-individual deductible, and the 
plan pays for 100 percent of covered expenses after a family has 
incurred out-of-pocket costs of $2,000. The plan provides that

[[Page 323]]

upon the divorce of a covered employee, coverage will end immediately 
for the employee's spouse and any children who do not remain in the 
employee's custody. An employee and spouse with three dependent children 
divorce on June 1, 2001, and one of the children remains with the 
employee. The spouse elects COBRA continuation coverage as of that date 
for the spouse and the other two children. During January through May of 
2001, the spouse incurred $600 of covered expenses and each of the two 
children in the spouse's custody after the divorce incurred covered 
expenses of $1,100. This resulted in total out-of-pocket costs for these 
three individuals of $800 ($300 total for the three deductibles, plus 
$500 for 20 percent of the other $2,500 in incurred expenses [$600 + 
$1,100 + $1,100 = $2,800; $2,800-$300 = $2,500]).
    (ii) For the remainder of 2001, the resulting family consisting of 
the spouse and two children has an out-of-pocket limit of $1,200 
($2,000-$800 = $1,200) . The remaining out-of-pocket limit for the 
resulting family consisting of the employee and one child is not subject 
to the rules of this Q&A-3 because their coverage is not COBRA 
continuation coverage.

    Q-4: Can a qualified beneficiary who elects COBRA continuation 
coverage ever change from the coverage received by that individual 
immediately before the qualifying event?
    A-4: (a) In general, a qualified beneficiary need only be given an 
opportunity to continue the coverage that she or he was receiving 
immediately before the qualifying event. This is true regardless of 
whether the coverage received by the qualified beneficiary before the 
qualifying event ceases to be of value to the qualified beneficiary, 
such as in the case of a qualified beneficiary covered under a region-
specific health maintenance organization (HMO) who leaves the HMO's 
service region. The only situations in which a qualified beneficiary 
must be allowed to change from the coverage received immediately before 
the qualifying event are as set forth in paragraphs (b) and (c) of this 
Q&A-4 and in Q&A-1 of this section (regarding changes to or elimination 
of the coverage provided to similarly situated nonCOBRA beneficiaries).
    (b) If a qualified beneficiary participates in a region-specific 
benefit package (such as an HMO or an on-site clinic) that will not 
service her or his health needs in the area to which she or he is 
relocating (regardless of the reason for the relocation), the qualified 
beneficiary must be given, within a reasonable period after requesting 
other coverage, an opportunity to elect alternative coverage that the 
employer or employee organization makes available to active employees. 
If the employer or employee organization makes group health plan 
coverage available to similarly situated nonCOBRA beneficiaries that can 
be extended in the area to which the qualified beneficiary is 
relocating, then that coverage is the alternative coverage that must be 
made available to the relocating qualified beneficiary. If the employer 
or employee organization does not make group health plan coverage 
available to similarly situated nonCOBRA beneficiaries that can be 
extended in the area to which the qualified beneficiary is relocating 
but makes coverage available to other employees that can be extended in 
that area, then the coverage made available to those other employees 
must be made available to the relocating qualified beneficiary. The 
effective date of the alternative coverage must be not later than the 
date of the qualified beneficiary's relocation, or, if later, the first 
day of the month following the month in which the qualified beneficiary 
requests the alternative coverage. However, the employer or employee 
organization is not required to make any other coverage available to the 
relocating qualified beneficiary if the only coverage the employer or 
employee organization makes available to active employees is not 
available in the area to which the qualified beneficiary relocates 
(because all such coverage is region-specific and does not service 
individuals in that area).
    (c) If an employer or employee organization makes an open enrollment 
period available to similarly situated active employees with respect to 
whom a qualifying event has not occurred, the same open enrollment 
period rights must be made available to each qualified beneficiary 
receiving COBRA continuation coverage. An open enrollment period means a 
period during which an employee covered under a plan can choose to be 
covered under another group health plan or under another benefit package 
within the same

[[Page 324]]

plan, or to add or eliminate coverage of family members.
    (d) The rules of this Q&A-4 are illustrated by the following 
examples:

    Example 1. (i) E is an employee who works for an employer that 
maintains several group health plans. Under the terms of the plans, if 
an employee chooses to cover any family members under a plan, all family 
members must be covered by the same plan and that plan must be the same 
as the plan covering the employee. Immediately before E's termination of 
employment (for reasons other than gross misconduct), E is covered along 
with E's spouse and children by a plan. The coverage under that plan 
will end as a result of the termination of employment.
    (ii) Upon E's termination of employment, each of the four family 
members is a qualified beneficiary. Even though the employer maintains 
various other plans and options, it is not necessary for the qualified 
beneficiaries to be allowed to switch to a new plan when E terminates 
employment.
    (iii) COBRA continuation coverage is elected for each of the four 
family members. Three months after E's termination of employment there 
is an open enrollment period during which similarly situated active 
employees are offered an opportunity to choose to be covered under a new 
plan or to add or eliminate family coverage.
    (iv) During the open enrollment period, each of the four qualified 
beneficiaries must be offered the opportunity to switch to another plan 
(as though each qualified beneficiary were an individual employee). For 
example, each member of E's family could choose coverage under a 
separate plan, even though the family members of employed individuals 
could not choose coverage under separate plans. Of course, if each 
family member chooses COBRA continuation coverage under a separate plan, 
the plan can require payment for each family member that is based on the 
applicable premium for individual coverage under that separate plan. See 
Q&A-1 of Sec. 54.4980B-8.
    Example 2. (i) The facts are the same as in Example 1, except that 
E's family members are not covered under E's group health plan when E 
terminates employment.
    (ii) Although the family members do not have to be given an 
opportunity to elect COBRA continuation coverage, E must be allowed to 
add them to E's COBRA continuation coverage during the open enrollment 
period. This is true even though the family members are not, and cannot 
become, qualified beneficiaries (see Q&A-1 of Sec. 54.4980B-3).

    Q-5: Aside from open enrollment periods, can a qualified beneficiary 
who has elected COBRA continuation coverage choose to cover individuals 
(such as newborn children, adopted children, or new spouses) who join 
the qualified beneficiary's family on or after the date of the 
qualifying event?
    A-5: (a) Yes. Under section 9801, employees eligible to participate 
in a group health plan (whether or not participating), as well as former 
employees participating in a plan (referred to in those rules as 
participants), are entitled to special enrollment rights for certain 
family members upon the loss of other group health plan coverage or upon 
the acquisition by the employee or participant of a new spouse or of a 
new dependent through birth, adoption, or placement for adoption, if 
certain requirements are satisfied. Employees not participating in the 
plan also can obtain rights for self-enrollment under those rules. Once 
a qualified beneficiary is receiving COBRA continuation coverage (that 
is, has timely elected and made timely payment for COBRA continuation 
coverage), the qualified beneficiary has the same right to enroll family 
members under those special enrollment rules as if the qualified 
beneficiary were an employee or participant within the meaning of those 
rules. However, neither a qualified beneficiary who is not receiving 
COBRA continuation coverage nor a former qualified beneficiary has any 
special enrollment rights under those rules.
    (b) In addition to the special enrollment rights described in 
paragraph (a) of this Q&A-5, if the plan covering the qualified 
beneficiary provides that new family members of active employees can 
become covered (either automatically or upon an appropriate election) 
before the next open enrollment period, then the same right must be 
extended to the new family members of a qualified beneficiary.
    (c) If the addition of a new family member will result in a higher 
applicable premium (for example, if the qualified beneficiary was 
previously receiving COBRA continuation coverage as an individual, or if 
the applicable premium for family coverage depends on family size), the 
plan can require the payment of a correspondingly higher amount for the 
COBRA continuation coverage. See Q&A-1 of Sec. 54.4980B-8.
    (d) The right to add new family members under this Q&A-5 is in 
addition to

[[Page 325]]

the rights that newborn and adopted children of covered employees may 
have as qualified beneficiaries; see Q&A-1 in Sec. 54.4980B-3.

[T.D. 8812, 64 FR 5180, Feb. 3, 1999, as amended by T.D. 8928, 66 FR 
1852, Jan. 10, 2001]



Sec. 54.4980B-6  Electing COBRA continuation coverage.

    The following questions-and-answers address the manner in which 
COBRA continuation coverage is elected:
    Q-1: What is the election period and how long must it last?
    A-1: (a) A group health plan can condition the availability of COBRA 
continuation coverage upon the timely election of such coverage. An 
election of COBRA continuation coverage is a timely election if it is 
made during the election period. The election period must begin not 
later than the date the qualified beneficiary would lose coverage on 
account of the qualifying event. (See paragraph (c) of Q&A-1 of Sec. 
54.4980B-4 for the meaning of lose coverage.) The election period must 
not end before the date that is 60 days after the later of--
    (1) The date the qualified beneficiary would lose coverage on 
account of the qualifying event; or
    (2) The date notice is provided to the qualified beneficiary of her 
or his right to elect COBRA continuation coverage.
    (b) An election is considered to be made on the date it is sent to 
the plan administrator.
    (c) The rules of this Q&A-1 are illustrated by the following 
example:

    Example. (i) An unmarried employee without children who is receiving 
employer-paid coverage under a group health plan voluntarily terminates 
employment on June 1, 2001. The employee is not disabled at the time of 
the termination of employment nor at any time thereafter, and the plan 
does not provide for the extension of the required periods (as is 
permitted under paragraph (b) of Q&A-4 of Sec. 54.4980B-7).
    (ii) Case 1: If the plan provides that the employer-paid coverage 
ends immediately upon the termination of employment, the election period 
must begin not later than June 1, 2001, and must not end earlier than 
July 31, 2001. If notice of the right to elect COBRA continuation 
coverage is not provided to the employee until June 15, 2001, the 
election period must not end earlier than August 14, 2001.
    (iii) Case 2: If the plan provides that the employer-paid coverage 
does not end until 6 months after the termination of employment, the 
employee does not lose coverage until December 1, 2001. The election 
period can therefore begin as late as December 1, 2001, and must not end 
before January 30, 2002.
    (iv) Case 3: If employer-paid coverage for 6 months after the 
termination of employment is offered only to those qualified 
beneficiaries who waive COBRA continuation coverage, the employee loses 
coverage on June 1, 2001, so the election period is the same as in Case 
1. The difference between Case 2 and Case 3 is that in Case 2 the 
employee can receive 6 months of employer-paid coverage and then elect 
to pay for up to an additional 12 months of COBRA continuation coverage, 
while in Case 3 the employee must choose between 6 months of employer-
paid coverage and paying for up to 18 months of COBRA continuation 
coverage. In all three cases, COBRA continuation coverage need not be 
provided for more than 18 months after the termination of employment 
(see Q&A-4 of Sec. 54.4980B-7), and in certain circumstances might be 
provided for a shorter period (see Q&A-1 of Sec. 54.4980B-7).

    Q-2: Is a covered employee or qualified beneficiary responsible for 
informing the plan administrator of the occurrence of a qualifying 
event?
    A-2: (a) In general, the employer or plan administrator must 
determine when a qualifying event has occurred. However, each covered 
employee or qualified beneficiary is responsible for notifying the plan 
administrator of the occurrence of a qualifying event that is either a 
dependent child's ceasing to be a dependent child under the generally 
applicable requirements of the plan or a divorce or legal separation of 
a covered employee. The group health plan is not required to offer the 
qualified beneficiary an opportunity to elect COBRA continuation 
coverage if the notice is not provided to the plan administrator within 
60 days after the later of--
    (1) The date of the qualifying event; or
    (2) The date the qualified beneficiary would lose coverage on 
account of the qualifying event.
    (b) For purposes of this Q&A-2, if more than one qualified 
beneficiary would lose coverage on account of a divorce or legal 
separation of a covered employee, a timely notice of the divorce or 
legal separation that is provided by the covered employee or any one of 
those qualified beneficiaries will

[[Page 326]]

be sufficient to preserve the election rights of all of the qualified 
beneficiaries.
    Q-3: During the election period and before the qualified beneficiary 
has made an election, must coverage be provided?
    A-3: (a) In general, each qualified beneficiary has until 60 days 
after the later of the date the qualifying event would cause her or him 
to lose coverage or the date notice is provided to the qualified 
beneficiary of her or his right to elect COBRA continuation coverage to 
decide whether to elect COBRA continuation coverage. If the election is 
made during that period, coverage must be provided from the date that 
coverage would otherwise have been lost (but see Q&A-4 of this section). 
This can be accomplished as described in paragraph (b) or (c) of this 
Q&A-3.
    (b) In the case of an indemnity or reimbursement arrangement, the 
employer or employee organization can provide for plan coverage during 
the election period or, if the plan allows retroactive reinstatement, 
the employer or employee organization can terminate the coverage of the 
qualified beneficiary and reinstate her or him when the election (and, 
if applicable, payment for the coverage) is made. Claims incurred by a 
qualified beneficiary during the election period do not have to be paid 
before the election (and, if applicable, payment for the coverage) is 
made. If a provider of health care (such as a physician, hospital, or 
pharmacy) contacts the plan to confirm coverage of a qualified 
beneficiary during the election period, the plan must give a complete 
response to the health care provider about the qualified beneficiary's 
COBRA continuation coverage rights during the election period. For 
example, if the plan provides coverage during the election period but 
cancels coverage retroactively if COBRA continuation coverage is not 
elected, then the plan must inform a provider that a qualified 
beneficiary for whom coverage has not been elected is covered but that 
the coverage is subject to retroactive termination. Similarly, if the 
plan cancels coverage but then retroactively reinstates it once COBRA 
continuation coverage is elected, then the plan must inform the provider 
that the qualified beneficiary currently does not have coverage but will 
have coverage retroactively to the date coverage was lost if COBRA 
continuation coverage is elected. (See paragraph (c) of Q&A-5 in Sec. 
54.4980B-8 for similar rules that a plan must follow in confirming 
coverage during a period when the plan has not received payment but that 
is still within the grace period for a qualified beneficiary for whom 
COBRA continuation coverage has been elected.)
    (c)(1) In the case of a group health plan that provides health 
services (such as a health maintenance organization or a walk-in 
clinic), the plan can require with respect to a qualified beneficiary 
who has not elected and paid for COBRA continuation coverage that the 
qualified beneficiary choose between--
    (i) Electing and paying for the coverage; or
    (ii) Paying the reasonable and customary charge for the plan's 
services, but only if a qualified beneficiary who chooses to pay for the 
services will be reimbursed for that payment within 30 days after the 
election of COBRA continuation coverage (and, if applicable, the payment 
of any balance due for the coverage).
    (2) In the alternative, the plan can provide continued coverage and 
treat the qualified beneficiary's use of the facility as a constructive 
election. In such a case, the qualified beneficiary is obligated to pay 
any applicable charge for the coverage, but only if the qualified 
beneficiary is informed that use of the facility will be a constructive 
election before using the facility.
    Q-4: Is a waiver before the end of the election period effective to 
end a qualified beneficiary's election rights?
    A-4: If, during the election period, a qualified beneficiary waives 
COBRA continuation coverage, the waiver can be revoked at any time 
before the end of the election period. Revocation of the waiver is an 
election of COBRA continuation coverage. However, if a waiver of COBRA 
continuation coverage is later revoked, coverage need not be provided 
retroactively (that is, from the date of the loss of coverage until the 
waiver is revoked). Waivers

[[Page 327]]

and revocations of waivers are considered made on the date they are sent 
to the employer, employee organization, or plan administrator, as 
applicable.
    Q-5: Can an employer or employee organization withhold money or 
other benefits owed to a qualified beneficiary until the qualified 
beneficiary either waives COBRA continuation coverage, elects and pays 
for such coverage, or allows the election period to expire?
    A-5: No. An employer, and an employee organization, must not 
withhold anything to which a qualified beneficiary is otherwise entitled 
(by operation of law or other agreement) in order to compel payment for 
COBRA continuation coverage or to coerce the qualified beneficiary to 
give up rights to COBRA continuation coverage (including the right to 
use the full election period to decide whether to elect such coverage). 
Such a withholding constitutes a failure to comply with the COBRA 
continuation coverage requirements. Furthermore, any purported waiver 
obtained by means of such a withholding is invalid.
    Q-6: Can each qualified beneficiary make an independent election 
under COBRA?
    A-6: Yes. Each qualified beneficiary (including a child who is born 
to or placed for adoption with a covered employee during a period of 
COBRA continuation coverage) must be offered the opportunity to make an 
independent election to receive COBRA continuation coverage. If the plan 
allows similarly situated active employees with respect to whom a 
qualifying event has not occurred to choose among several options during 
an open enrollment period (for example, to switch to another group 
health plan or to another benefit package under the same group health 
plan), then each qualified beneficiary must also be offered an 
independent election to choose during an open enrollment period among 
the options made available to similarly situated active employees with 
respect to whom a qualifying event has not occurred. If a qualified 
beneficiary who is either a covered employee or the spouse of a covered 
employee elects COBRA continuation coverage and the election does not 
specify whether the election is for self-only coverage, the election is 
deemed to include an election of COBRA continuation coverage on behalf 
of all other qualified beneficiaries with respect to that qualifying 
event. An election on behalf of a minor child can be made by the child's 
parent or legal guardian. An election on behalf of a qualified 
beneficiary who is incapacitated or dies can be made by the legal 
representative of the qualified beneficiary or the qualified 
beneficiary's estate, as determined under applicable state law, or by 
the spouse of the qualified beneficiary. (See also Q&A-5 of Sec. 
54.4980B-7 relating to the independent right of each qualified 
beneficiary with respect to the same qualifying event to receive COBRA 
continuation coverage during the disability extension.) The rules of 
this Q&A-6 are illustrated by the following examples; in each example 
each group health plan is subject to COBRA:

    Example 1. (i) Employee H and H 's spouse are covered under a group 
health plan immediately before H 's termination of employment (for 
reasons other than gross misconduct). Coverage under the plan will end 
as a result of the termination of employment.
    (ii) Upon H 's termination of employment, both H and H 's spouse are 
qualified beneficiaries and each must be allowed to elect COBRA 
continuation coverage. Thus, H might elect COBRA continuation coverage 
while the spouse declines to elect such coverage, or H might elect COBRA 
continuation coverage for both of them. In contrast, H cannot decline 
COBRA continuation coverage on behalf of H 's spouse. Thus, if H does 
not elect COBRA continuation coverage on behalf of the spouse, the 
spouse must still be allowed to elect COBRA continuation coverage.
    Example 2. (i) An employer maintains a group health plan under which 
all employees receive employer-paid coverage. Employees can arrange to 
cover their families by paying an additional amount. The employer also 
maintains a cafeteria plan, under which one of the options is to pay 
part or all of the employee share of the cost for family coverage under 
the group health plan. Thus, an employee might pay for family coverage 
under the group health plan partly with before-tax dollars and partly 
with after-tax dollars.
    (ii) If an employee's family is receiving coverage under the group 
health plan when a qualifying event occurs, each of the qualified 
beneficiaries must be offered an opportunity to elect COBRA continuation 
coverage, regardless of how that qualified beneficiary's

[[Page 328]]

coverage was paid for before the qualifying event.

[T.D. 8812, 64 FR 5182, Feb. 3, 1999, as amended by T.D. 8928, 66 FR 
1853, Jan. 10, 2001]



Sec. 54.4980B-7  Duration of COBRA continuation coverage.

    The following questions-and-answers address the duration of COBRA 
continuation coverage:
    Q-1: How long must COBRA continuation coverage be made available to 
a qualified beneficiary?
    A-1: (a) Except for an interruption of coverage in connection with a 
waiver, as described in Q&A-4 of Sec. 54.4980B-6, COBRA continuation 
coverage that has been elected for a qualified beneficiary must extend 
for at least the period beginning on the date of the qualifying event 
and ending not before the earliest of the following dates--
    (1) The last day of the maximum coverage period (see Q&A-4 of this 
section);
    (2) The first day for which timely payment is not made to the plan 
with respect to the qualified beneficiary (see Q&A-5 in Sec. 54.4980B-
8);
    (3) The date upon which the employer or employee organization ceases 
to provide any group health plan (including successor plans) to any 
employee;
    (4) The date, after the date of the election, upon which the 
qualified beneficiary first becomes covered under any other group health 
plan, as described in Q&A-2 of this section;
    (5) The date, after the date of the election, upon which the 
qualified beneficiary first becomes entitled to Medicare benefits, as 
described in Q&A-3 of this section; and
    (6) In the case of a qualified beneficiary entitled to a disability 
extension (see Q&A-5 of this section), the later of--
    (i) Either 29 months after the date of the qualifying event, or the 
first day of the month that is more than 30 days after the date of a 
final determination under Title II or XVI of the Social Security Act (42 
U.S.C. 401-433 or 1381-1385) that the disabled qualified beneficiary 
whose disability resulted in the qualified beneficiary's being entitled 
to the disability extension is no longer disabled, whichever is earlier; 
or
    (ii) The end of the maximum coverage period that applies to the 
qualified beneficiary without regard to the disability extension.
    (b) However, a group health plan can terminate for cause the 
coverage of a qualified beneficiary receiving COBRA continuation 
coverage on the same basis that the plan terminates for cause the 
coverage of similarly situated nonCOBRA beneficiaries. For example, if a 
group health plan terminates the coverage of active employees for the 
submission of a fraudulent claim, then the coverage of a qualified 
beneficiary can also be terminated for the submission of a fraudulent 
claim. Notwithstanding the preceding two sentences, the coverage of a 
qualified beneficiary can be terminated for failure to make timely 
payment to the plan only if payment is not timely under the rules of 
Q&A-5 in Sec. 54.4980B-8.
    (c) In the case of an individual who is not a qualified beneficiary 
and who is receiving coverage under a group health plan solely because 
of the individual's relationship to a qualified beneficiary, if the 
plan's obligation to make COBRA continuation coverage available to the 
qualified beneficiary ceases under this section, the plan is not 
obligated to make coverage available to the individual who is not a 
qualified beneficiary.
    Q-2: When may a plan terminate a qualified beneficiary's COBRA 
continuation coverage due to coverage under another group health plan?
    A-2: (a) If a qualified beneficiary first becomes covered under 
another group health plan (including for this purpose any group health 
plan of a governmental employer or employee organization) after the date 
on which COBRA continuation coverage is elected for the qualified 
beneficiary and the other coverage satisfies the requirements of 
paragraphs (b), (c), and (d) of this Q&A-2, then the plan may terminate 
the qualified beneficiary's COBRA continuation coverage upon the date on 
which the qualified beneficiary first becomes covered under the other 
group health plan (even if the other coverage is less valuable to the 
qualified beneficiary). By contrast, if a qualified beneficiary first 
becomes covered under another

[[Page 329]]

group health plan on or before the date on which COBRA continuation 
coverage is elected, then the other coverage cannot be a basis for 
terminating the qualified beneficiary's COBRA continuation coverage.
    (b) The requirement of this paragraph (b) is satisfied if the 
qualified beneficiary is actually covered, rather than merely eligible 
to be covered, under the other group health plan.
    (c) The requirement of this paragraph (c) is satisfied if the other 
group health plan is a plan that is not maintained by the employer or 
employee organization that maintains the plan under which COBRA 
continuation coverage must otherwise be made available.
    (d) The requirement of this paragraph (d) is satisfied if the other 
group health plan does not contain any exclusion or limitation with 
respect to any preexisting condition of the qualified beneficiary (other 
than such an exclusion or limitation that does not apply to, or is 
satisfied by, the qualified beneficiary by reason of the provisions in 
section 9801 (relating to limitations on preexisting condition exclusion 
periods in group health plans)).
    (e) The rules of this Q&A-2 are illustrated by the following 
examples:

    Example 1. (i) Employer X maintains a group health plan subject to 
COBRA. C is an employee covered under the plan. C is also covered under 
a group health plan maintained by Employer Y, the employer of C 's 
spouse. C terminates employment (for reasons other than gross 
misconduct), and the termination of employment causes C to lose coverage 
under X 's plan (and, thus, is a qualifying event). C elects to receive 
COBRA continuation coverage under X 's plan.
    (ii) Under these facts, X 's plan cannot terminate C 's COBRA 
continuation coverage on the basis of C 's coverage under Y 's plan.
    Example 2. (i) Employer W maintains a group health plan subject to 
COBRA. D is an employee covered under the plan. D terminates employment 
(for reasons other than gross misconduct), and the termination of 
employment causes D to lose coverage under W 's plan (and, thus, is a 
qualifying event). D elects to receive COBRA continuation coverage under 
W 's plan. Later D becomes employed by Employer V and is covered under V 
's group health plan. D 's coverage under V 's plan is not subject to 
any exclusion or limitation with respect to any preexisting condition of 
D.
    (ii) Under these facts, W can terminate D 's COBRA continuation 
coverage on the date D becomes covered under V 's plan.
    Example 3. (i) The facts are the same as in Example 2, except that D 
becomes employed by V and becomes covered under V 's group health plan 
before D elects COBRA continuation coverage under W 's plan.
    (ii) Because the termination of employment is a qualifying event, D 
must be offered COBRA continuation coverage under W 's plan, and W is 
not permitted to terminate D 's COBRA continuation coverage on account 
of D 's coverage under V 's plan because D first became covered under V 
's plan before COBRA continuation coverage was elected for D.

    Q-3: When may a plan terminate a qualified beneficiary's COBRA 
continuation coverage due to the qualified beneficiary's entitlement to 
Medicare benefits?
    A-3: (a) If a qualified beneficiary first becomes entitled to 
Medicare benefits under Title XVIII of the Social Security Act (42 
U.S.C. 1395-1395ggg) after the date on which COBRA continuation coverage 
is elected for the qualified beneficiary, then the plan may terminate 
the qualified beneficiary's COBRA continuation coverage upon the date on 
which the qualified beneficiary becomes so entitled. By contrast, if a 
qualified beneficiary first becomes entitled to Medicare benefits on or 
before the date that COBRA continuation coverage is elected, then the 
qualified beneficiary's entitlement to Medicare benefits cannot be a 
basis for terminating the qualified beneficiary's COBRA continuation 
coverage.
    (b) A qualified beneficiary becomes entitled to Medicare benefits 
upon the effective date of enrollment in either part A or B, whichever 
occurs earlier. Thus, merely being eligible to enroll in Medicare does 
not constitute being entitled to Medicare benefits.
    Q-4: When does the maximum coverage period end?
    A-4: (a) Except as otherwise provided in this Q&A-4, the maximum 
coverage period ends 36 months after the qualifying event. The maximum 
coverage period for a qualified beneficiary who is a child born to or 
placed for adoption with a covered employee during a period of COBRA 
continuation coverage is the maximum coverage period for the qualifying 
event giving rise to the

[[Page 330]]

period of COBRA continuation coverage during which the child was born or 
placed for adoption. Paragraph (b) of this Q&A-4 describes the starting 
point from which the end of the maximum coverage period is measured. The 
date that the maximum coverage period ends is described in paragraph (c) 
of this Q&A-4 in a case where the qualifying event is a termination of 
employment or reduction of hours of employment, in paragraph (d) of this 
Q&A-4 in a case where a covered employee becomes entitled to Medicare 
benefits under Title XVIII of the Social Security Act (42 U.S.C. 1395-
1395ggg) before experiencing a qualifying event that is a termination of 
employment or reduction of hours of employment, and in paragraph (e) of 
this Q&A-4 in the case of a qualifying event that is the bankruptcy of 
the employer. See Q&A-8 of Sec. 54.4980B-2 for limitations that apply 
to certain health flexible spending arrangements. See also Q&A-6 of this 
section in the case of multiple qualifying events. Nothing in Sec. Sec. 
54.4980B-1 through 54.4980B-10 prohibits a group health plan from 
providing coverage that continues beyond the end of the maximum coverage 
period.
    (b)(1) The end of the maximum coverage period is measured from the 
date of the qualifying event even if the qualifying event does not 
result in a loss of coverage under the plan until a later date. If, 
however, coverage under the plan is lost at a later date and the plan 
provides for the extension of the required periods, then the maximum 
coverage period is measured from the date when coverage is lost. A plan 
provides for the extension of the required periods if it provides both--
    (i) That the 30-day notice period (during which the employer is 
required to notify the plan administrator of the occurrence of certain 
qualifying events such as the death of the covered employee or the 
termination of employment or reduction of hours of employment of the 
covered employee) begins on the date of the loss of coverage rather than 
on the date of the qualifying event; and
    (ii) That the end of the maximum coverage period is measured from 
the date of the loss of coverage rather than from the date of the 
qualifying event.
    (2) In the case of a plan that provides for the extension of the 
required periods, whenever the rules of Sec. Sec. 54.4980B-1 through 
54.4980B-10 refer to the measurement of a period from the date of the 
qualifying event, those rules apply in such a case by measuring the 
period instead from the date of the loss of coverage.
    (c) In the case of a qualifying event that is a termination of 
employment or reduction of hours of employment, the maximum coverage 
period ends 18 months after the qualifying event if there is no 
disability extension, and 29 months after the qualifying event if there 
is a disability extension. See Q&A-5 of this section for rules to 
determine if there is a disability extension. If there is a disability 
extension and the disabled qualified beneficiary is later determined to 
no longer be disabled, then a plan may terminate the COBRA continuation 
coverage of an affected qualified beneficiary before the end of the 
disability extension; see paragraph (a)(6) in Q&A-1 of this section.
    (d)(1) If a covered employee becomes entitled to Medicare benefits 
under Title XVIII of the Social Security Act (42 U.S.C. 1395-1395ggg) 
before experiencing a qualifying event that is a termination of 
employment or reduction of hours of employment, the maximum coverage 
period for qualified beneficiaries other than the covered employee ends 
on the later of--
    (i) 36 months after the date the covered employee became entitled to 
Medicare benefits; or
    (ii) 18 months (or 29 months, if there is a disability extension) 
after the date of the covered employee's termination of employment or 
reduction of hours of employment.
    (2) See paragraph (b) of Q&A-3 of this section regarding the 
determination of when a covered employee becomes entitled to Medicare 
benefits.
    (e) In the case of a qualifying event that is the bankruptcy of the 
employer, the maximum coverage period for a qualified beneficiary who is 
the retired covered employee ends on the date of the retired covered 
employee's death. The maximum coverage period for a qualified 
beneficiary who is the spouse, surviving spouse, or dependent

[[Page 331]]

child of the retired covered employee ends on the earlier of--
    (1) The date of the qualified beneficiary's death; or
    (2) The date that is 36 months after the death of the retired 
covered employee.
    Q-5: How does a qualified beneficiary become entitled to a 
disability extension?
    A-5: (a) A qualified beneficiary becomes entitled to a disability 
extension if the requirements of paragraphs (b), (c), and (d) of this 
Q&A-5 are satisfied with respect to the qualified beneficiary. If the 
disability extension applies with respect to a qualifying event, it 
applies with respect to each qualified beneficiary entitled to COBRA 
continuation coverage because of that qualifying event. Thus, for 
example, the 29-month maximum coverage period applies to each qualified 
beneficiary who is not disabled as well as to the qualified beneficiary 
who is disabled, and it applies independently with respect to each of 
the qualified beneficiaries. See Q&A-1 in Sec. 54.4980B-8, which 
permits a plan to require payment of an increased amount during the 
disability extension.
    (b) The requirement of this paragraph (b) is satisfied if a 
qualifying event occurs that is a termination, or reduction of hours, of 
a covered employee's employment.
    (c) The requirement of this paragraph (c) is satisfied if an 
individual (whether or not the covered employee) who is a qualified 
beneficiary in connection with the qualifying event described in 
paragraph (b) of this Q&A-5 is determined under Title II or XVI of the 
Social Security Act (42 U.S.C. 401-433 or 1381-1385) to have been 
disabled at any time during the first 60 days of COBRA continuation 
coverage. For this purpose, the period of the first 60 days of COBRA 
continuation coverage is measured from the date of the qualifying event 
described in paragraph (b) of this Q&A-5 (except that if a loss of 
coverage would occur at a later date in the absence of an election for 
COBRA continuation coverage and if the plan provides for the extension 
of the required periods (as described in paragraph (b) of Q&A-4 of this 
section) then the period of the first 60 days of COBRA continuation 
coverage is measured from the date on which the coverage would be lost). 
However, in the case of a qualified beneficiary who is a child born to 
or placed for adoption with a covered employee during a period of COBRA 
continuation coverage, the period of the first 60 days of COBRA 
continuation coverage is measured from the date of birth or placement 
for adoption. For purposes of this paragraph (c), an individual is 
determined to be disabled within the first 60 days of COBRA continuation 
coverage if the individual has been determined under Title II or XVI of 
the Social Security Act to have been disabled before the first day of 
COBRA continuation coverage and has not been determined to be no longer 
disabled at any time between the date of that disability determination 
and the first day of COBRA continuation coverage.
    (d) The requirement of this paragraph (d) is satisfied if any of the 
qualified beneficiaries affected by the qualifying event described in 
paragraph (b) of this Q&A-5 provides notice to the plan administrator of 
the disability determination on a date that is both within 60 days after 
the date the determination is issued and before the end of the original 
18-month maximum coverage period that applies to the qualifying event.
    Q-6: Under what circumstances can the maximum coverage period be 
expanded?
    A-6: (a) The maximum coverage period can be expanded if the 
requirements of Q&A-5 of this section (relating to the disability 
extension) or paragraph (b) of this Q&A-6 are satisfied.
    (b) The requirements of this paragraph (b) are satisfied if a 
qualifying event that gives rise to an 18-month maximum coverage period 
(or a 29-month maximum coverage period in the case of a disability 
extension) is followed, within that 18-month period (or within that 29-
month period, in the case of a disability extension), by a second 
qualifying event (for example, a death or a divorce) that gives rise to 
a 36-month maximum coverage period. (Thus, a termination of employment 
following a qualifying event that is a reduction of hours of employment 
cannot be a second qualifying event that

[[Page 332]]

expands the maximum coverage period; the bankruptcy of an employer also 
cannot be a second qualifying event that expands the maximum coverage 
period.) In such a case, the original 18-month period (or 29-month 
period, in the case of a disability extension) is expanded to 36 months, 
but only for those individuals who were qualified beneficiaries under 
the group health plan in connection with the first qualifying event and 
who are still qualified beneficiaries at the time of the second 
qualifying event. No qualifying event (other than a qualifying event 
that is the bankruptcy of the employer) can give rise to a maximum 
coverage period that ends more than 36 months after the date of the 
first qualifying event (or more than 36 months after the date of the 
loss of coverage, in the case of a plan that provides for the extension 
of the required periods; see paragraph (b) in Q&A-4 of this section). 
For example, if an employee covered by a group health plan that is 
subject to COBRA terminates employment (for reasons other than gross 
misconduct) on December 31, 2000, the termination is a qualifying event 
giving rise to a maximum coverage period that extends for 18 months to 
June 30, 2002. If the employee dies after the employee and the 
employee's spouse and dependent children have elected COBRA continuation 
coverage and on or before June 30, 2002, the spouse and dependent 
children (except anyone among them whose COBRA continuation coverage had 
already ended for some other reason) will be able to receive COBRA 
continuation coverage through December 31, 2003. See Q&A-8(b) of Sec. 
54.4980B-2 for a special rule that applies to certain health flexible 
spending arrangements.
    Q-7: If health coverage is provided to a qualified beneficiary after 
a qualifying event without regard to COBRA continuation coverage (for 
example, as a result of state or local law, the Uniformed Services 
Employment and Reemployment Rights Act of 1994 (38 U.S.C. 4315), 
industry practice, a collective bargaining agreement, severance 
agreement, or plan procedure), will such alternative coverage extend the 
maximum coverage period?
    A-7: (a) No. The end of the maximum coverage period is measured 
solely as described in Q&A-4 and Q&A-6 of this section, which is 
generally from the date of the qualifying event.
    (b) If the alternative coverage does not satisfy all the 
requirements for COBRA continuation coverage, or if the amount that the 
group health plan requires to be paid for the alternative coverage is 
greater than the amount required to be paid by similarly situated 
nonCOBRA beneficiaries for the coverage that the qualified beneficiary 
can elect to receive as COBRA continuation coverage, the plan covering 
the qualified beneficiary immediately before the qualifying event must 
offer the qualified beneficiary receiving the alternative coverage the 
opportunity to elect COBRA continuation coverage. See Q&A-1 of Sec. 
54.4980B-6.
    (c) If an individual rejects COBRA continuation coverage in favor of 
alternative coverage, then, at the expiration of the alternative 
coverage period, the individual need not be offered a COBRA election. 
However, if the individual receiving alternative coverage is a covered 
employee and the spouse or a dependent child of the individual would 
lose that alternative coverage as a result of a qualifying event (such 
as the death of the covered employee), the spouse or dependent child 
must be given an opportunity to elect to continue that alternative 
coverage, with a maximum coverage period of 36 months measured from the 
date of that qualifying event.
    Q-8: Must a qualified beneficiary be given the right to enroll in a 
conversion health plan at the end of the maximum coverage period for 
COBRA continuation coverage?
    A-8: If a qualified beneficiary's COBRA continuation coverage under 
a group health plan ends as a result of the expiration of the maximum 
coverage period, the group health plan must, during the 180-day period 
that ends on that expiration date, provide the qualified beneficiary the 
option of enrolling under a conversion health plan if such an option is 
otherwise generally available to similarly situated nonCOBRA 
beneficiaries under the group health plan. If such a conversion

[[Page 333]]

option is not otherwise generally available, it need not be made 
available to qualified beneficiaries.

[T.D. 8812, 64 FR 5184, Feb. 3, 1999, as amended by T.D. 8928, 66 FR 
1853, Jan. 10, 2001]



Sec. 54.4980B-8  Paying for COBRA continuation coverage.

    The following questions-and-answers address paying for COBRA 
continuation coverage:
    Q-1: Can a group health plan require payment for COBRA continuation 
coverage?
    A-1: (a) Yes. For any period of COBRA continuation coverage, a group 
health plan can require the payment of an amount that does not exceed 
102 percent of the applicable premium for that period. (See paragraph 
(b) of this Q&A-1 for a rule permitting a plan to require payment of an 
increased amount due to the disability extension.) The applicable 
premium is defined in section 4980B(f)(4). A group health plan can 
terminate a qualified beneficiary's COBRA continuation coverage as of 
the first day of any period for which timely payment is not made to the 
plan with respect to that qualified beneficiary (see Q&A-1 of Sec. 
54.4980B-7). For the meaning of timely payment, see Q&A-5 of this 
section.
    (b) A group health plan is permitted to require the payment of an 
amount that does not exceed 150 percent of the applicable premium for 
any period of COBRA continuation coverage covering a disabled qualified 
beneficiary (for example, whether single or family coverage) if the 
coverage would not be required to be made available in the absence of a 
disability extension. (See Q&A-5 of Sec. 54.4980B-7 for rules to 
determine whether a qualified beneficiary is entitled to a disability 
extension.) A plan is not permitted to require the payment of an amount 
that exceeds 102 percent of the applicable premium for any period of 
COBRA continuation coverage to which a qualified beneficiary is entitled 
without regard to the disability extension. Thus, if a qualified 
beneficiary entitled to a disability extension experiences a second 
qualifying event within the original 18-month maximum coverage period, 
then the plan is not permitted to require the payment of an amount that 
exceeds 102 percent of the applicable premium for any period of COBRA 
continuation coverage. By contrast, if a qualified beneficiary entitled 
to a disability extension experiences a second qualifying event after 
the end of the original 18-month maximum coverage period, then the plan 
may require the payment of an amount that is up to 150 percent of the 
applicable premium for the remainder of the period of COBRA continuation 
coverage (that is, from the beginning of the 19th month through the end 
of the 36th month) as long as the disabled qualified beneficiary is 
included in that coverage. The rules of this paragraph (b) are 
illustrated by the following examples; in each example the group health 
plan is subject to COBRA:

    Example 1. (i) An employer maintains a group health plan. The plan 
determines the cost of covering individuals under the plan by reference 
to two categories, individual coverage and family coverage, and the 
applicable premium is determined for those two categories. An employee 
and members of the employee's family are covered under the plan. The 
employee experiences a qualifying event that is the termination of the 
employee's employment. The employee's family qualifies for the 
disability extension because of the disability of the employee's spouse. 
(Timely notice of the disability is provided to the plan administrator.) 
Timely payment of the amount required by the plan for COBRA continuation 
coverage for the family (which does not exceed 102 percent of the cost 
of family coverage under the plan) was made to the plan with respect to 
the employee's family for the first 18 months of COBRA continuation 
coverage, and the disabled spouse and the rest of the family continue to 
receive COBRA continuation coverage through the 29th month.
    (ii) Under these facts, the plan may require payment of up to 150 
percent of the applicable premium for family coverage in order for the 
family to receive COBRA continuation coverage from the 19th month 
through the 29th month. If the plan determined the cost of coverage by 
reference to three categories (such as employee, employee-plus-one-
dependent, employee-plus-two-or-more-dependents) or more than three 
categories, instead of two categories, the plan could still require, 
from the 19th month through the 29th month of COBRA continuation 
coverage, the payment of 150 percent of the cost of coverage for the 
category of coverage that included the disabled spouse.
    Example 2. (i) The facts are the same as in Example 1, except that 
only the covered employee elects and pays for the first 18 months of 
COBRA continuation coverage.

[[Page 334]]

    (ii) Even though the employee's disabled spouse does not elect or 
pay for COBRA continuation coverage, the employee satisfies the 
requirements for the disability extension to apply with respect to the 
employee's qualifying event. Under these facts, the plan may not require 
the payment of more than 102 percent of the applicable premium for 
individual coverage for the entire period of the employee's COBRA 
continuation coverage, including the period from the 19th month through 
the 29th month. If COBRA continuation coverage had been elected and paid 
for with respect to other nondisabled members of the employee's family, 
then the plan could not require the payment of more than 102 percent of 
the applicable premium for family coverage (or for any other appropriate 
category of coverage that might apply to that group of qualified 
beneficiaries under the plan, such as employee-plus-one-dependent or 
employee-plus-two-or-more-dependents) for those family members to 
continue their coverage from the 19th month through the 29th month.

    (c) A group health plan does not fail to comply with section 9802(b) 
(which generally prohibits an individual from being charged, on the 
basis of health status, a higher premium than that charged for similarly 
situated individuals enrolled in the plan) with respect to a qualified 
beneficiary entitled to the disability extension merely because the plan 
requires payment of an amount permitted under paragraph (b) of this Q&A-
1.
    Q-2: When is the applicable premium determined and when can a group 
health plan increase the amount it requires to be paid for COBRA 
continuation coverage?
    A-2: (a) The applicable premium for each determination period must 
be computed and fixed by a group health plan before the determination 
period begins. A determination period is any 12-month period selected by 
the plan, but it must be applied consistently from year to year. The 
determination period is a single period for any benefit package. Thus, 
each qualified beneficiary does not have a separate determination period 
beginning on the date (or anniversaries of the date) that COBRA 
continuation coverage begins for that qualified beneficiary.
    (b) During a determination period, a plan can increase the amount it 
requires to be paid for a qualified beneficiary's COBRA continuation 
coverage only in the following three cases:
    (1) The plan has previously charged less than the maximum amount 
permitted under Q&A-1 of this section and the increased amount required 
to be paid does not exceed the maximum amount permitted under Q&A-1 of 
this section;
    (2) The increase occurs during the disability extension and the 
increased amount required to be paid does not exceed the maximum amount 
permitted under paragraph (b) of Q&A-1 of this section; or
    (3) A qualified beneficiary changes the coverage being received (see 
paragraph (c) of this Q&A-2 for rules on how the amount the plan 
requires to be paid may or must change when a qualified beneficiary 
changes the coverage being received).
    (c) If a plan allows similarly situated active employees who have 
not experienced a qualifying event to change the coverage they are 
receiving, then the plan must also allow each qualified beneficiary to 
change the coverage being received on the same terms as the similarly 
situated active employees. (See Q&A-4 in Sec. 54.4980B-5.) If a 
qualified beneficiary changes coverage from one benefit package (or a 
group of benefit packages) to another benefit package (or another group 
of benefit packages), or adds or eliminates coverage for family members, 
then the following rules apply. If the change in coverage is to a 
benefit package, group of benefit packages, or coverage unit (such as 
family coverage, self-plus-one-dependent, or self-plus-two-or-more-
dependents) for which the applicable premium is higher, then the plan 
may increase the amount that it requires to be paid for COBRA 
continuation coverage to an amount that does not exceed the amount 
permitted under Q&A-1 of this section as applied to the new coverage. If 
the change in coverage is to a benefit package, group of benefit 
packages, or coverage unit (such as individual or self-plus-one-
dependent) for which the applicable premium is lower, then the plan 
cannot require the payment of an amount that exceeds the amount 
permitted under Q&A-1 of this section as applied to the new coverage.
    Q-3: Must a plan allow payment for COBRA continuation coverage to be 
made in monthly installments?

[[Page 335]]

    A-3: Yes. A group health plan must allow payment for COBRA 
continuation coverage to be made in monthly installments. A group health 
plan is permitted to also allow the alternative of payment for COBRA 
continuation coverage being made at other intervals (for example, 
weekly, quarterly, or semiannually).
    Q-4: Is a plan required to allow a qualified beneficiary to choose 
to have the first payment for COBRA continuation coverage applied 
prospectively only?
    A-4: No. A plan is permitted to apply the first payment for COBRA 
continuation coverage to the period of coverage beginning immediately 
after the date on which coverage under the plan would have been lost on 
account of the qualifying event. Of course, if the group health plan 
allows a qualified beneficiary to waive COBRA continuation coverage for 
any period before electing to receive COBRA continuation coverage, the 
first payment is not applied to the period of the waiver.
    Q-5: What is timely payment for COBRA continuation coverage?
    A-5: (a) Except as provided in this paragraph (a) or in paragraph 
(b) or (d) of this Q&A-5, timely payment for a period of COBRA 
continuation coverage under a group health plan means payment that is 
made to the plan by the date that is 30 days after the first day of that 
period. Payment that is made to the plan by a later date is also 
considered timely payment if either--
    (1) Under the terms of the plan, covered employees or qualified 
beneficiaries are allowed until that later date to pay for their 
coverage for the period; or
    (2) Under the terms of an arrangement between the employer or 
employee organization and an insurance company, health maintenance 
organization, or other entity that provides plan benefits on the 
employer's or employee organization's behalf, the employer or employee 
organization is allowed until that later date to pay for coverage of 
similarly situated nonCOBRA beneficiaries for the period.
    (b) Notwithstanding paragraph (a) of this Q&A-5, a plan cannot 
require payment for any period of COBRA continuation coverage for a 
qualified beneficiary earlier than 45 days after the date on which the 
election of COBRA continuation coverage is made for that qualified 
beneficiary.
    (c) If, after COBRA continuation coverage has been elected for a 
qualified beneficiary, a provider of health care (such as a physician, 
hospital, or pharmacy) contacts the plan to confirm coverage of a 
qualified beneficiary for a period for which the plan has not yet 
received payment, the plan must give a complete response to the health 
care provider about the qualified beneficiary's COBRA continuation 
coverage rights, if any, described in paragraphs (a), (b), and (d) of 
this Q&A-5. For example, if the plan provides coverage during the 30- 
and 45-day grace periods described in paragraphs (a) and (b) of this 
Q&A-5 but cancels coverage retroactively if payment is not made by the 
end of the applicable grace period, then the plan must inform a provider 
with respect to a qualified beneficiary for whom payment has not been 
received that the qualified beneficiary is covered but that the coverage 
is subject to retroactive termination if timely payment is not made. 
Similarly, if the plan cancels coverage if it has not received payment 
by the first day of a period of coverage but retroactively reinstates 
coverage if payment is made by the end of the grace period for that 
period of coverage, then the plan must inform the provider that the 
qualified beneficiary currently does not have coverage but will have 
coverage retroactively to the first date of the period if timely payment 
is made. (See paragraph (b) of Q&A-3 in Sec. 54.4980B-6 for similar 
rules that the plan must follow in confirming coverage during the 
election period.)
    (d) If timely payment is made to the plan in an amount that is not 
significantly less than the amount the plan requires to be paid for a 
period of coverage, then the amount paid is deemed to satisfy the plan's 
requirement for the amount that must be paid, unless the plan notifies 
the qualified beneficiary of the amount of the deficiency and grants a 
reasonable period of time for payment of the deficiency to be made. For 
this purpose, as a safe harbor, 30 days after the date the notice is 
provided is deemed to be a reasonable

[[Page 336]]

period of time. An amount is not significantly less than the amount the 
plan requires to be paid for a period of coverage if and only if the 
shortfall is no greater than the lesser of the following two amounts:
    (1) Fifty dollars (or such other amount as the Commissioner may 
provide in a revenue ruling, notice, or other guidance published in the 
Internal Revenue Bulletin (see Sec. 601.601(d)(2)(ii) of this 
chapter)); or
    (2) 10 percent of the amount the plan requires to be paid.
    (e) Payment is considered made on the date on which it is sent to 
the plan.

[T.D. 8812, 64 FR 5186, Feb. 3, 1999, as amended by T.D. 8928, 66 FR 
1854, Jan. 10, 2001]



Sec. 54.4980B-9  Business reorganizations and employer withdrawals 
from multiemployer plans.

    The following questions-and-answers address who has the obligation 
to make COBRA continuation coverage available to affected qualified 
beneficiaries in the context of business reorganizations and employer 
withdrawals from multiemployer plans:
    Q-1: For purposes of this section, what are a business 
reorganization, a stock sale, and an asset sale?
    A-1: For purposes of this section:
    (a) A business reorganization is a stock sale or an asset sale.
    (b) A stock sale is a transfer of stock in a corporation that causes 
the corporation to become a different employer or a member of a 
different employer. (See Q&A-2 of Sec. 54.4980B-2, which defines 
employer to include all members of a controlled group of corporations.) 
Thus, for example, a sale or distribution of stock in a corporation that 
causes the corporation to cease to be a member of one controlled group 
of corporations, whether or not it becomes a member of another 
controlled group of corporations, is a stock sale.
    (c) An asset sale is a transfer of substantial assets, such as a 
plant or division or substantially all the assets of a trade or 
business.
    (d) The rules of Sec. 1.414(b)-1 of this chapter apply in 
determining what constitutes a controlled group of corporations, and the 
rules of Sec. Sec. 1.414(c)-1 through 1.414(c)-5 of this chapter apply 
in determining what constitutes a group of trades or businesses under 
common control.
    Q-2: In the case of a stock sale, what are the selling group, the 
acquired organization, and the buying group?
    A-2: In the case of a stock sale--
    (a) The selling group is the controlled group of corporations, or 
the group of trades or businesses under common control, of which a 
corporation ceases to be a member as a result of the stock sale;
    (b) The acquired organization is the corporation that ceases to be a 
member of the selling group as a result of the stock sale; and
    (c) The buying group is the controlled group of corporations, or the 
group of trades or businesses under common control, of which the 
acquired organization becomes a member as a result of the stock sale. If 
the acquired organization does not become a member of such a group, the 
buying group is the acquired organization.
    Q-3: In the case of an asset sale, what are the selling group and 
the buying group?
    A-3: In the case of an asset sale--
    (a) The selling group is the controlled group of corporations or the 
group of trades or businesses under common control that includes the 
corporation or other trade or business that is selling the assets; and
    (b) The buying group is the controlled group of corporations or the 
group of trades or businesses under common control that includes the 
corporation or other trade or business that is buying the assets.
    Q-4: Who is an M&A qualified beneficiary?
    A-4: (a) Asset sales: In the case of an asset sale, an individual is 
an M&A qualified beneficiary if the individual is a qualified 
beneficiary whose qualifying event occurred prior to or in connection 
with the sale and who is, or whose qualifying event occurred in 
connection with, a covered employee whose last employment prior to the 
qualifying event was associated with the assets being sold.
    (b) Stock sales: In the case of a stock sale, an individual is an 
M&A qualified beneficiary if the individual is a qualified beneficiary 
whose qualifying event occurred prior to or in connection with

[[Page 337]]

the sale and who is, or whose qualifying event occurred in connection 
with, a covered employee whose last employment prior to the qualifying 
event was with the acquired organization.
    (c) In the case of a qualified beneficiary who has experienced more 
than one qualifying event with respect to her or his current right to 
COBRA continuation coverage, the qualifying event referred to in 
paragraphs (a) and (b) of this Q&A-4 is the first qualifying event.
    Q-5: In the case of a stock sale, is the sale a qualifying event 
with respect to a covered employee who is employed by the acquired 
organization before the sale and who continues to be employed by the 
acquired organization after the sale, or with respect to the spouse or 
dependent children of such a covered employee?
    A-5: No. A covered employee who continues to be employed by the 
acquired organization after the sale does not experience a termination 
of employment as a result of the sale. Accordingly, the sale is not a 
qualifying event with respect to the covered employee, or with respect 
to the covered employee's spouse or dependent children, regardless of 
whether they are provided with group health coverage after the sale, and 
neither the covered employee, nor the covered employee's spouse or 
dependent children, become qualified beneficiaries as a result of the 
sale.
    Q-6: In the case of an asset sale, is the sale a qualifying event 
with respect to a covered employee whose employment immediately before 
the sale was associated with the purchased assets, or with respect to 
the spouse or dependent children of such a covered employee who are 
covered under a group health plan of the selling group immediately 
before the sale?
    A-6: (a) Yes, unless--
    (1) The buying group is a successor employer under paragraph (c) of 
Q&A-8 of this section or Q&A-2 of Sec. 54.4980B-2, and the covered 
employee is employed by the buying group immediately after the sale; or
    (2) The covered employee (or the spouse or any dependent child of 
the covered employee) does not lose coverage (within the meaning of 
paragraph (c) in Q&A-1 of Sec. 54.4980B-4) under a group health plan of 
the selling group after the sale.
    (b) Unless the conditions in paragraph (a)(1) or (2) of this Q&A-6 
are satisfied, such a covered employee experiences a termination of 
employment with the selling group as a result of the asset sale, 
regardless of whether the covered employee is employed by the buying 
group or whether the covered employee's employment is associated with 
the purchased assets after the sale. Accordingly, the covered employee, 
and the spouse and dependent children of the covered employee who lose 
coverage under a plan of the selling group in connection with the sale, 
are M&A qualified beneficiaries in connection with the sale.
    Q-7: In a business reorganization, are the buying group and the 
selling group permitted to allocate by contract the responsibility to 
make COBRA continuation coverage available to M&A qualified 
beneficiaries?
    A-7: Yes. Nothing in this section prohibits a selling group and a 
buying group from allocating to one or the other of the parties in a 
purchase agreement the responsibility to provide the coverage required 
under Sec. Sec. 54.4980B-1 through 54.4980B-10. However, if and to the 
extent that the party assigned this responsibility under the terms of 
the contract fails to perform, the party who has the obligation under 
Q&A-8 of this section to make COBRA continuation coverage available to 
M&A qualified beneficiaries continues to have that obligation.
    Q-8: Which group health plan has the obligation to make COBRA 
continuation coverage available to M&A qualified beneficiaries in a 
business reorganization?
    A-8: (a) In the case of a business reorganization (whether a stock 
sale or an asset sale), so long as the selling group maintains a group 
health plan after the sale, a group health plan maintained by the 
selling group has the obligation to make COBRA continuation coverage 
available to M&A qualified beneficiaries with respect to that sale. This 
Q&A-8 prescribes rules for cases in

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which the selling group ceases to provide any group health plan to any 
employee in connection with the sale. Paragraph (b) of this Q&A-8 
contains these rules for stock sales, and paragraph (c) of this Q&A-8 
contains these rules for asset sales. Neither a stock sale nor an asset 
sale has any effect on the COBRA continuation coverage requirements 
applicable to any group health plan for any period before the sale.
    (b)(1) In the case of a stock sale, if the selling group ceases to 
provide any group health plan to any employee in connection with the 
sale, a group health plan maintained by the buying group has the 
obligation to make COBRA continuation coverage available to M&A 
qualified beneficiaries with respect to that stock sale. A group health 
plan of the buying group has this obligation beginning on the later of 
the following two dates and continuing as long as the buying group 
continues to maintain a group health plan (but subject to the rules in 
Sec. 54.4980B-7, relating to the duration of COBRA continuation 
coverage)--
    (i) The date the selling group ceases to provide any group health 
plan to any employee; or
    (ii) The date of the stock sale.
    (2) The determination of whether the selling group's cessation of 
providing any group health plan to any employee is in connection with 
the stock sale is based on all of the relevant facts and circumstances. 
A group health plan of the buying group does not, as a result of the 
stock sale, have an obligation to make COBRA continuation coverage 
available to those qualified beneficiaries of the selling group who are 
not M&A qualified beneficiaries with respect to that sale.
    (c)(1) In the case of an asset sale, if the selling group ceases to 
provide any group health plan to any employee in connection with the 
sale and if the buying group continues the business operations 
associated with the assets purchased from the selling group without 
interruption or substantial change, then the buying group is a successor 
employer to the selling group in connection with that asset sale. A 
buying group does not fail to be a successor employer in connection with 
an asset sale merely because the asset sale takes place in connection 
with a proceeding in bankruptcy under Title 11 of the United States 
Code. If the buying group is a successor employer, a group health plan 
maintained by the buying group has the obligation to make COBRA 
continuation coverage available to M&A qualified beneficiaries with 
respect to that asset sale. A group health plan of the buying group has 
this obligation beginning on the later of the following two dates and 
continuing as long as the buying group continues to maintain a group 
health plan (but subject to the rules in Sec. 54.4980B-7, relating to 
the duration of COBRA continuation coverage)--
    (i) The date the selling group ceases to provide any group health 
plan to any employee; or
    (ii) The date of the asset sale.
    (2) The determination of whether the selling group's cessation of 
providing any group health plan to any employee is in connection with 
the asset sale is based on all of the relevant facts and circumstances. 
A group health plan of the buying group does not, as a result of the 
asset sale, have an obligation to make COBRA continuation coverage 
available to those qualified beneficiaries of the selling group who are 
not M&A qualified beneficiaries with respect to that sale.
    (d) The rules of Q&A-1 through Q&A-7 of this section and this Q&A-8 
are illustrated by the following examples; in each example, each group 
health plan is subject to COBRA:

                           Stock Sale Examples

    Example 1. (i) Selling Group S consists of three corporations, A, B, 
and C. Buying Group P consists of two corporations, D and E. P enters 
into a contract to purchase all the stock of C from S effective July 1, 
2002. Before the sale of C, S maintains a single group health plan for 
the employees of A, B, and C (and their families). P maintains a single 
group health plan for the employees of D and E (and their families). 
Effective July 1, 2002, the employees of C (and their families) become 
covered under P's plan. On June 30, 2002, there are 48 qualified 
beneficiaries receiving COBRA continuation coverage under S's plan, 15 
of whom are M&A qualified beneficiaries with respect to the sale of C. 
(The other 33 qualified beneficiaries had qualifying events in 
connection with a covered

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employee whose last employment before the qualifying event was with 
either A or B.)
    (ii) Under these facts, S's plan continues to have the obligation to 
make COBRA continuation coverage available to the 15 M&A qualified 
beneficiaries under S's plan after the sale of C to P. The employees who 
continue in employment with C do not experience a qualifying event by 
virtue of P's acquisition of C. If they experience a qualifying event 
after the sale, then the group health plan of P has the obligation to 
make COBRA continuation coverage available to them.
    Example 2. (i) Selling Group S consists of three corporations, A, B, 
and C. Each of A, B, and C maintains a group health plan for its 
employees (and their families). Buying Group P consists of two 
corporations, D and E. P enters into a contract to purchase all of the 
stock of C from S effective July 1, 2002. As of June 30, 2002, there are 
14 qualified beneficiaries receiving COBRA continuation coverage under 
C's plan. C continues to employ all of its employees and continues to 
maintain its group health plan after being acquired by P on July 1, 
2002.
    (ii) Under these facts, C is an acquired organization and the 14 
qualified beneficiaries under C's plan are M&A qualified beneficiaries. 
A group health plan of S (that is, either the plan maintained by A or 
the plan maintained by B) has the obligation to make COBRA continuation 
coverage available to the 14 M&A qualified beneficiaries. S and P could 
negotiate to have C's plan continue to make COBRA continuation coverage 
available to the 14 M&A qualified beneficiaries. In such a case, neither 
A's plan nor B's plan would make COBRA continuation coverage available 
to the 14 M&A qualified beneficiaries unless C's plan failed to fulfill 
its contractual responsibility to make COBRA continuation coverage 
available to the M&A qualified beneficiaries. C's employees (and their 
spouses and dependent children) do not experience a qualifying event in 
connection with P's acquisition of C, and consequently no plan 
maintained by either P or S has any obligation to make COBRA 
continuation coverage available to C's employees (or their spouses or 
dependent children) in connection with the transfer of stock in C from S 
to P.
    Example 3. (i) The facts are the same as in Example 2, except that C 
ceases to employ two employees on June 30, 2002, and those two employees 
never become covered under P's plan.
    (ii) Under these facts, the two employees experience a qualifying 
event on June 30, 2002 because their termination of employment causes a 
loss of group health coverage. A group health plan of S (that is, either 
the plan maintained by A or the plan maintained by B) has the obligation 
to make COBRA continuation coverage available to the two employees (and 
to any spouse or dependent child of the two employees who loses coverage 
under C's plan in connection with the termination of employment of the 
two employees) because they are M&A qualified beneficiaries with respect 
to the sale of C.
    Example 4. (i) Selling Group S consists of three corporations, A, B, 
and C. Buying Group P consists of two corporations, D and E. P enters 
into a contract to purchase all of the stock of C from S effective July 
1, 2002. Before the sale of C, S maintains a single group health plan 
for the employees of A, B, and C (and their families). P maintains a 
single group health plan for the employees of D and E (and their 
families). Effective July 1, 2002, the employees of C (and their 
families) become covered under P's plan. On June 30, 2002, there are 25 
qualified beneficiaries receiving COBRA continuation coverage under S's 
plan, 20 of whom are M&A qualified beneficiaries with respect to the 
sale of C. (The other five qualified beneficiaries had qualifying events 
in connection with a covered employee whose last employment before the 
qualifying event was with either A or B.) S terminates its group health 
plan effective June 30, 2002 and begins to liquidate the assets of A and 
B and to lay off the employees of A and B.
    (ii) Under these facts, S ceases to provide a group health plan to 
any employee in connection with the sale of C to P. Thus, beginning July 
1, 2002 P's plan has the obligation to make COBRA continuation coverage 
available to the 20 M&A qualified beneficiaries, but P is not obligated 
to make COBRA continuation coverage available to the other 5 qualified 
beneficiaries with respect to S's plan as of June 30, 2002 or to any of 
the employees of A or B whose employment is terminated by S (or to any 
of those employees' spouses or dependent children).

                           Asset Sale Examples

    Example 5. (i) Selling Group S provides group health plan coverage 
to employees at each of its operating divisions. S sells the assets of 
one of its divisions to Buying Group P. Under the terms of the group 
health plan covering the employees at the division being sold, their 
coverage will end on the date of the sale. P hires all but one of those 
employees, gives them the same positions that they had with S before the 
sale, and provides them with coverage under a group health plan. 
Immediately before the sale, there are two qualified beneficiaries 
receiving COBRA continuation coverage under a group health plan of S 
whose qualifying events occurred in connection with a covered employee 
whose last employment prior to the qualifying event was associated with 
the assets sold to P.
    (ii) These two qualified beneficiaries are M&A qualified 
beneficiaries with respect to the asset sale to P. Under these facts, a 
group health plan of S retains the obligation

[[Page 340]]

to make COBRA continuation coverage available to these two M&A qualified 
beneficiaries. In addition, the one employee P does not hire as well as 
all of the employees P hires (and the spouses and dependent children of 
these employees) who were covered under a group health plan of S on the 
day before the sale are M&A qualified beneficiaries with respect to the 
sale. A group health plan of S also has the obligation to make COBRA 
continuation coverage available to these M&A qualified beneficiaries.
    Example 6. (i) Selling Group S provides group health plan coverage 
to employees at each of its operating divisions. S sells substantially 
all of the assets of all of its divisions to Buying Group P, and S 
ceases to provide any group health plan to any employee on the date of 
the sale. P hires all but one of S's employees on the date of the asset 
sale by S, gives those employees the same positions that they had with S 
before the sale, and continues the business operations of those 
divisions without substantial change or interruption. P provides these 
employees with coverage under a group health plan. Immediately before 
the sale, there are 10 qualified beneficiaries receiving COBRA 
continuation coverage under a group health plan of S whose qualifying 
events occurred in connection with a covered employee whose last 
employment prior to the qualifying event was associated with the assets 
sold to P.
    (ii) These 10 qualified beneficiaries are M&A qualified 
beneficiaries with respect to the asset sale to P. Under these facts, P 
is a successor employer described in paragraph (c) of this Q&A-8. Thus, 
a group health plan of P has the obligation to make COBRA continuation 
coverage available to these 10 M&A qualified beneficiaries.
    (iii) The one employee that P does not hire and the family members 
of that employee are also M&A qualified beneficiaries with respect to 
the sale. A group health plan of P also has the obligation to make COBRA 
continuation coverage available to these M&A qualified beneficiaries.
    (iv) The employees who continue in employment in connection with the 
asset sale (and their family members) and who were covered under a group 
health plan of S on the day before the sale are not M&A qualified 
beneficiaries because P is a successor employer to S in connection with 
the asset sale. Thus, no group health plan of P has any obligation to 
make COBRA continuation coverage available to these continuing employees 
with respect to the qualifying event that resulted from their losing 
coverage under S's plan in connection with the asset sale.
    Example 7. (i) Selling Group S provides group health plan coverage 
to employees at each of its two operating divisions. S sells the assets 
of one of its divisions to Buying Group P1. Under the terms of the group 
health plan covering the employees at the division being sold, their 
coverage will end on the date of the sale. P1 hires all but one of those 
employees, gives them the same positions that they had with S before the 
sale, and provides them with coverage under a group health plan.
    (ii) Under these facts, a group health plan of S has the obligation 
to make COBRA continuation coverage available to M&A qualified 
beneficiaries with respect to the sale to P1. (If an M&A qualified 
beneficiary first became covered under P1's plan after electing COBRA 
continuation coverage under S's plan, then S's plan could terminate the 
COBRA continuation coverage once the M&A qualified beneficiary became 
covered under P1's plan, provided that the remaining conditions of Q&A-2 
of Sec. 54.4980B-7 were satisfied.)
    (iii) Several months after the sale to P1, S sells the assets of its 
remaining division to Buying Group P2, and S ceases to provide any group 
health plan to any employee on the date of that sale. Thus, under Q&A-1 
of Sec. 54.4980B-7, S ceases to have an obligation to make COBRA 
continuation coverage available to any qualified beneficiary on the date 
of the sale to P2. P1 and P2 are unrelated organizations.
    (iv) Even if it was foreseeable that S would sell its remaining 
division to an unrelated third party after the sale to P1, under these 
facts the cessation of S to provide any group health plan to any 
employee on the date of the sale to P2 is not in connection with the 
asset sale to P1. Thus, even after the date S ceases to provide any 
group health plan to any employee, no group health plan of P1 has any 
obligation to make COBRA continuation coverage available to M&A 
qualified beneficiaries with respect to the asset sale to P1 by S. If P2 
is a successor employer under the rules of paragraph (c) of this Q&A-8 
and maintains one or more group health plans after the sale, then a 
group health plan of P2 would have an obligation to make COBRA 
continuation coverage available to M&A qualified beneficiaries with 
respect to the asset sale to P2 by S (but in such a case employees of S 
before the sale who continued working for P2 after the sale would not be 
M&A qualified beneficiaries). However, even in such a case, no group 
health plan of P2 would have an obligation to make COBRA continuation 
coverage available to M&A qualified beneficiaries with respect to the 
asset sale to P1 by S. Thus, under these facts, after S has ceased to 
provide any group health plan to any employee, no plan has an obligation 
to make COBRA continuation coverage available to M&A qualified 
beneficiaries with respect to the asset sale to P1.
    Example 8. (i) Selling Group S provides group health plan coverage 
to employees at each of its operating divisions. S sells substantially 
all of the assets of all of its divisions to Buying Group P. P hires 
most of S's employees on the date of the purchase of S's

[[Page 341]]

assets, retains those employees in the same positions that they had with 
S before the purchase, and continues the business operations of those 
divisions without substantial change or interruption. P provides these 
employees with coverage under a group health plan. S continues to employ 
a few employees for the principal purpose of winding up the affairs of S 
in preparation for liquidation. S continues to provide coverage under a 
group health plan to these few remaining employees for several weeks 
after the date of the sale and then ceases to provide any group health 
plan to any employee.
    (ii) Under these facts, the cessation by S to provide any group 
health plan to any employee is in connection with the asset sale to P. 
Because of this, and because P continued the business operations 
associated with those assets without substantial change or interruption, 
P is a successor employer to S with respect to the asset sale. Thus, a 
group health plan of P has the obligation to make COBRA continuation 
coverage available to M&A qualified beneficiaries with respect to the 
sale beginning on the date that S ceases to provide any group health 
plan to any employee. (A group health plan of S retains this obligation 
for the several weeks after the date of the sale until S ceases to 
provide any group health plan to any employee.)
    Q-9: Can the cessation of contributions by an employer to a 
multiemployer group health plan be a qualifying event?
    A-9: The cessation of contributions by an employer to a 
multiemployer group health plan is not itself a qualifying event, even 
though the cessation of contributions may cause current employees (and 
their spouses and dependent children) to lose coverage under the 
multiemployer plan. An event coinciding with the employer's cessation of 
contributions (such as a reduction of hours of employment in the case of 
striking employees) will constitute a qualifying event if it otherwise 
satisfies the requirements of Q&A-1 of Sec. 54.4980B-4.
    Q-10: If an employer stops contributing to a multiemployer group 
health plan, does the multiemployer plan have the obligation to make 
COBRA continuation coverage available to a qualified beneficiary who was 
receiving coverage under the multiemployer plan on the day before the 
cessation of contributions and who is, or whose qualifying event 
occurred in connection with, a covered employee whose last employment 
prior to the qualifying event was with the employer that has stopped 
contributing to the multiemployer plan?
    A-10: (a) In general, yes. (See Q&A-3 of Sec. 54.4980B-2 for a 
definition of multiemployer plan.) If, however, the employer that stops 
contributing to the multiemployer plan makes group health plan coverage 
available to (or starts contributing to another multiemployer plan that 
is a group health plan with respect to) a class of the employer's 
employees formerly covered under the multiemployer plan, the plan 
maintained by the employer (or the other multiemployer plan), from that 
date forward, has the obligation to make COBRA continuation coverage 
available to any qualified beneficiary who was receiving coverage under 
the multiemployer plan on the day before the cessation of contributions 
and who is, or whose qualifying event occurred in connection with, a 
covered employee whose last employment prior to the qualifying event was 
with the employer.
    (b) The rules of Q&A-9 of this section and this Q&A-10 are 
illustrated by the following examples; in each example, each group 
health plan is subject to COBRA:

    Example 1. (i) Employer Z employs a class of employees covered by a 
collective bargaining agreement and participating in multiemployer group 
health plan M. As required by the collective bargaining agreement, Z has 
been making contributions to M. Z experiences financial difficulties and 
stops making contributions to M but continues to employ all of the 
employees covered by the collective bargaining agreement. Z's cessation 
of contributions to M causes those employees (and their spouses and 
dependent children) to lose coverage under M. Z does not make group 
health plan coverage available to any of the employees covered by the 
collective bargaining agreement.
    (ii) After Z stops contributing to M, M continues to have the 
obligation to make COBRA continuation coverage available to any 
qualified beneficiary who experienced a qualifying event that preceded 
or coincided with the cessation of contributions to M and whose coverage 
under M on the day before the qualifying event was due to an employment 
affiliation with Z. The loss of coverage under M for those employees of 
Z who continue in employment (and the loss of coverage for their spouses 
and dependent children) does not constitute a qualifying event.

[[Page 342]]

    Example 2. (i) The facts are the same as in Example 1 except that B, 
one of the employees covered under M before Z stops contributing to M, 
is transferred into management. Z maintains a group health plan for 
managers and B becomes eligible for coverage under the plan on the day 
of B's transfer.
    (ii) Under these facts, Z does not make group health plan coverage 
available to a class of employees formerly covered under M after B 
becomes eligible under Z's group health plan for managers. Accordingly, 
M continues to have the obligation to make COBRA continuation coverage 
available to any qualified beneficiary who experienced a qualifying 
event that preceded or coincided with the cessation of contributions to 
M and whose coverage under M on the day before the qualifying event was 
due to an employment affiliation with Z.
    Example 3. (i) Employer Y employs two classes of employees--skilled 
and unskilled laborers--covered by a collective bargaining agreement and 
participating in multiemployer group health plan M. As required by the 
collective bargaining agreement, Y has been making contributions to M. Y 
stops making contributions to M but continues to employ all the 
employees covered by the collective bargaining agreement. Y's cessation 
of contributions to M causes those employees (and their spouses and 
dependent children) to lose coverage under M. Y makes group health plan 
coverage available to the skilled laborers immediately after their 
coverage ceases under M, but Y does not make group health plan coverage 
available to any of the unskilled laborers.
    (ii) Under these facts, because Y makes group health plan coverage 
available to a class of employees previously covered under M immediately 
after both classes of employees lose coverage under M, Y alone has the 
obligation to make COBRA continuation coverage available to any 
qualified beneficiary who experienced a qualifying event that preceded 
or coincided with the cessation of contributions to M and whose coverage 
under M on the day before the qualifying event was due to an employment 
affiliation with Y, regardless of whether the employment affiliation was 
as a skilled or unskilled laborer. However, the loss of coverage under M 
for those employees of Y who continue in employment (and the loss of 
coverage for their spouses and dependent children) does not constitute a 
qualifying event.
    Example 4. (i) Employer X employs a class of employees covered by a 
collective bargaining agreement and participating in multiemployer group 
health plan M. As required by the collective bargaining agreement, X has 
been making contributions to M. X experiences financial difficulties and 
is forced into bankruptcy by its creditors. X continues to employ all of 
the employees covered by the collective bargaining agreement. X also 
continues to make contributions to M until the current collective 
bargaining agreement expires, on June 30, 2001, and then X stops making 
contributions to M. X's employees (and their spouses and dependent 
children) lose coverage under M effective July 1, 2001. X does not enter 
into another collective bargaining agreement covering the class of 
employees covered by the expired collective bargaining agreement. 
Effective September 1, 2001, X establishes a group health plan covering 
the class of employees formerly covered by the collective bargaining 
agreement. The group health plan also covers their spouses and dependent 
children.
    (ii) Under these facts, M has the obligation to make COBRA 
continuation coverage available from July 1, 2001 until August 31, 2001, 
and the group health plan established by X has the obligation to make 
COBRA continuation coverage available from September 1, 2001 until the 
obligation ends (see Q&A-1 of Sec. 54.4980B-7) to any qualified 
beneficiary who experienced a qualifying event that preceded or 
coincided with the cessation of contributions to M and whose coverage 
under M on the day before the qualifying event was due to an employment 
affiliation with X. The loss of coverage under M for those employees of 
X who continue in employment (and the loss of coverage for their spouses 
and dependent children) does not constitute a qualifying event.
    Example 5. (i) Employer W employs a class of employees covered by a 
collective bargaining agreement and participating in multiemployer group 
health plan M. As required by the collective bargaining agreement, W has 
been making contributions to M. The employees covered by the collective 
bargaining agreement vote to decertify their current employee 
representative effective January 1, 2002 and vote to certify a new 
employee representative effective the same date. As a consequence, on 
January 1, 2002 they cease to be covered under M and commence to be 
covered under multiemployer group health plan N.
    (ii) Effective January 1, 2002, N has the obligation to make COBRA 
continuation coverage available to any qualified beneficiary who 
experienced a qualifying event that preceded or coincided with the 
cessation of contributions to M and whose coverage under M on the day 
before the qualifying event was due to an employment affiliation with W. 
The loss of coverage under M for those employees of W who continue in 
employment (and the loss of coverage for their spouses and dependent 
children) does not constitute a qualifying event.

[T.D. 8928, 66 FR 1855, Jan. 10, 2001]

[[Page 343]]



Sec. 54.4980B-10  Interaction of FMLA and COBRA.

    The following questions-and-answers address how the taking of leave 
under the Family and Medical Leave Act of 1993 (FMLA) (29 U.S.C. 2601-
2619) affects the COBRA continuation coverage requirements:
    Q-1: In what circumstances does a qualifying event occur if an 
employee does not return from leave taken under FMLA?
    A-1: (a) The taking of leave under FMLA does not constitute a 
qualifying event. A qualifying event under Q&A-1 of Sec. 54.4980B-4 
occurs, however, if--
    (1) An employee (or the spouse or a dependent child of the employee) 
is covered on the day before the first day of FMLA leave (or becomes 
covered during the FMLA leave) under a group health plan of the 
employee's employer;
    (2) The employee does not return to employment with the employer at 
the end of the FMLA leave; and
    (3) The employee (or the spouse or a dependent child of the 
employee) would, in the absence of COBRA continuation coverage, lose 
coverage under the group health plan before the end of the maximum 
coverage period.
    (b) However, the satisfaction of the three conditions in paragraph 
(a) of this Q&A-1 does not constitute a qualifying event if the employer 
eliminates, on or before the last day of the employee's FMLA leave, 
coverage under a group health plan for the class of employees (while 
continuing to employ that class of employees) to which the employee 
would have belonged if the employee had not taken FMLA leave.
    Q-2: If a qualifying event described in Q&A-1 of this section 
occurs, when does it occur, and how is the maximum coverage period 
measured?
    A-2: A qualifying event described in Q&A-1 of this section occurs on 
the last day of FMLA leave. (The determination of when FMLA leave ends 
is not made under the rules of this section. See the FMLA regulations, 
29 CFR Part 825 (Sec. Sec. 825.100-825.800).) The maximum coverage 
period (see Q&A-4 of Sec. 54.4980B-7) is measured from the date of the 
qualifying event (that is, the last day of FMLA leave). If, however, 
coverage under the group health plan is lost at a later date and the 
plan provides for the extension of the required periods (see paragraph 
(b) of Q&A-4 of Sec. 54.4980B-7), then the maximum coverage period is 
measured from the date when coverage is lost. The rules of this Q&A-2 
are illustrated by the following examples:

    Example 1. (i) Employee B is covered under the group health plan of 
Employer X on January 31, 2001. B takes FMLA leave beginning February 1, 
2001. B's last day of FMLA leave is 12 weeks later, on April 25, 2001, 
and B does not return to work with X at the end of the FMLA leave. If B 
does not elect COBRA continuation coverage, B will not be covered under 
the group health plan of X as of April 26, 2001.
    (ii) B experiences a qualifying event on April 25, 2001, and the 
maximum coverage period is measured from that date. (This is the case 
even if, for part or all of the FMLA leave, B fails to pay the employee 
portion of premiums for coverage under the group health plan of X and is 
not covered under X's plan. See Q&A-3 of this section.)
    Example 2. (i) Employee C and C's spouse are covered under the group 
health plan of Employer Y on August 15, 2001. C takes FMLA leave 
beginning August 16, 2001. C informs Y less than 12 weeks later, on 
September 28, 2001, that C will not be returning to work. Under the FMLA 
regulations, 29 CFR Part 825 (Sec. Sec. 825.100-825.800), C's last day 
of FMLA leave is September 28, 2001. C does not return to work with Y at 
the end of the FMLA leave. If C and C's spouse do not elect COBRA 
continuation coverage, they will not be covered under the group health 
plan of Y as of September 29, 2001.
    (ii) C and C's spouse experience a qualifying event on September 28, 
2001, and the maximum coverage period (generally 18 months) is measured 
from that date. (This is the case even if, for part or all of the FMLA 
leave, C fails to pay the employee portion of premiums for coverage 
under the group health plan of Y and C or C's spouse is not covered 
under Y's plan. See Q&A-3 of this section.)

    Q-3: If an employee fails to pay the employee portion of premiums 
for coverage under a group health plan during FMLA leave or declines 
coverage under a group health plan during FMLA leave, does this affect 
the determination of whether or when the employee has experienced a 
qualifying event?
    A-3: No. Any lapse of coverage under a group health plan during FMLA 
leave is irrelevant in determining whether a set of circumstances 
constitutes a qualifying event under Q&A-1 of this

[[Page 344]]

section or when such a qualifying event occurs under Q&A-2 of this 
section.
    Q-4: Is the application of the rules in Q&A-1 through Q&A-3 of this 
section affected by a requirement of state or local law to provide a 
period of coverage longer than that required under FMLA?
    A-4: No. Any state or local law that requires coverage under a group 
health plan to be maintained during a leave of absence for a period 
longer than that required under FMLA (for example, for 16 weeks of leave 
rather than for the 12 weeks required under FMLA) is disregarded for 
purposes of determining when a qualifying event occurs under Q&A-1 
through Q&A-3 of this section.
    Q-5: May COBRA continuation coverage be conditioned upon 
reimbursement of the premiums paid by the employer for coverage under a 
group health plan during FMLA leave?
    A-5: No. The U.S. Department of Labor has published rules describing 
the circumstances in which an employer may recover premiums it pays to 
maintain coverage, including family coverage, under a group health plan 
during FMLA leave from an employee who fails to return from leave. See 
29 CFR 825.213. Even if recovery of premiums is permitted under 29 CFR 
825.213, the right to COBRA continuation coverage cannot be conditioned 
upon the employee's reimbursement of the employer for premiums the 
employer paid to maintain coverage under a group health plan during FMLA 
leave.

[T.D. 8928, 66 FR 1855, Jan. 10, 2001]



Sec. 54.4980D-1  Requirement of return and time for filing of the excise
tax under section 4980D.

    Q-1: If a person is liable for the excise tax under section 4980D, 
what form must the person file and what is the due date for the filing 
and payment of the excise tax?
    A-1: (a) In general. See Sec. Sec. 54.6011-2 and 54.6151-1.
    (b) Due date for filing of return by employers. See Sec. 54.6071-
1(b)(1).
    (c) Due date for filing of return by multiemployer plans or multiple 
employer health plans. See Sec. 54.6071-1(b)(2).
    (d) Effective/applicability date. In the case of an employer or 
other person mentioned in paragraph (b) of this Q & A-1, the rules in 
this Q & A-1 are effective for taxable years beginning on or after 
January 1, 2010. In the case of a plan mentioned in paragraph (c) of 
this Q & A-1, the rules in this Q & A-1 are effective for plan years 
beginning on or after January 1, 2010.

[T.D. 9457, 74 FR 45997, Sept. 8, 2009]



Sec. 54.4980E-1  Requirement of return and time for filing of the excise
tax under section 4980E.

    Q-1: If a person is liable for the excise tax under section 4980E, 
what form must the person file and what is the due date for the filing 
and payment of the excise tax?
    A-1: (a) In general. See Sec. Sec. 54.6011-2, 54.6151-1 and 
54.6071-1(c).
    (b) Effective/applicability date. The rules in this Q & A-1 are 
effective for plan years beginning on or after January 1, 2010.

[T.D. 9457, 74 FR 45997, Sept. 8, 2009]



Sec. 54.4980F-1  Notice requirements for certain pension plan 
amendments significantly reducing the rate of future benefit accrual.

    The following questions and answers concern the notification 
requirements imposed by 4980F of the Internal Revenue Code and section 
204(h) of ERISA relating to a plan amendment of an applicable pension 
plan that significantly reduces the rate of future benefit accrual or 
that eliminates or significantly reduces an early retirement benefit or 
retirement-type subsidy.

                            List of Questions

Q-1. What are the notice requirements of section 4980F(e) of the 
          Internal Revenue Code and section 204(h) of ERISA?
Q-2. What are the differences between section 4980F and section 204(h)?
Q-3. What is an ``applicable pension plan'' to which section 4980F and 
          section 204(h) apply?
Q-4. What is ``section 204(h) notice'' and what is a ``section 204(h) 
          amendment''?
Q-5. For which amendments is section 204(h) notice required?
Q-6. What is an amendment that reduces the rate of future benefit 
          accrual or reduces an early retirement benefit or retirement-
          type subsidy for purposes of determining whether section 
          204(h) notice is required?

[[Page 345]]

Q-7. What plan provisions are taken into account in determining whether 
          an amendment is a section 204(h) amendment?
Q-8. What is the basic principle used in determining whether a reduction 
          in the rate of future benefit accrual or a reduction in an 
          early retirement benefit or retirement-type subsidy is 
          significant for purposes of section 4980F and section 204(h)?
Q-9. When must section 204(h) notice be provided?
Q-10. To whom must section 204(h) notice be provided?
Q-11. What information is required to be provided in a section 204(h) 
          notice?
Q-12. What special rules apply if participants can choose between the 
          old and new benefit formulas?
Q-13. How may section 204(h) notice be provided?
Q-14. What are the consequences if a plan administrator fails to provide 
          section 204(h) notice?
Q-15. What are some of the rules that apply with respect to the excise 
          tax under section 4980F?
Q-16. How do section 4980F and section 204(h) apply when a business is 
          sold?
Q-17. How are amendments to cease accruals and terminate a plan treated 
          under section 4980F and section 204(h)?
Q-18. What are the effective dates of section 4980F, section 204(h), as 
          amended by EGTRRA, and these regulations?

                          Questions and Answers

    Q-1. What are the notice requirements of section 4980F(e) of the 
Internal Revenue Code and section 204(h) of ERISA?
    A-1. (a) Requirements of Internal Revenue Code section 4980F(e) and 
ERISA section 204(h). Section 4980F of the Internal Revenue Code 
(section 4980F) and section 204(h) of the Employee Retirement Income 
Security Act of 1974, as amended (ERISA), 29 U.S.C. 1054(h) (section 
204(h)) each generally requires notice of an amendment to an applicable 
pension plan that either provides for a significant reduction in the 
rate of future benefit accrual or that eliminates or significantly 
reduces an early retirement benefit or retirement-type subsidy. The 
notice is required to be provided to plan participants and alternate 
payees who are applicable individuals (as defined in Q&A-10 of this 
section), to certain employee organizations, and to contributing 
employers under a multiemployer plan (as described in Q&A-10(a) of this 
section). The plan administrator must generally provide the notice 
before the effective date of the plan amendment. Q&A-9 of this section 
sets forth the time frames for providing notice, Q&A-11 of this section 
sets forth the content requirements for the notice, and Q&A-12 of this 
section contains special rules for cases in which participants can 
choose between the old and new benefit formulas.
    (b) Other notice requirements. Other provisions of law may require 
that certain parties be notified of a plan amendment. See, for example, 
sections 102 and 104 of ERISA, and the regulations thereunder, for 
requirements relating to summary plan descriptions and summaries of 
material modifications.
    Q-2. What are the differences between section 4980F and section 
204(h)?
    A-2. The notice requirements of section 4980F generally are parallel 
to the notice requirements of section 204(h), as amended by the Economic 
Growth and Tax Relief Reconciliation Act of 2001, Public Law 107-16 (115 
Stat. 38) (2001) (EGTRRA). However, the consequences of the failure to 
satisfy the requirements of the two provisions differ: Section 4980F 
imposes an excise tax on a failure to satisfy the notice requirements, 
while section 204(h)(6), as amended by EGTRRA, contains a special rule 
with respect to an egregious failure to satisfy the notice requirements. 
See Q&A-14 and Q&A-15 of this section. Except to the extent specifically 
indicated, these regulations apply both to section 4980F and to section 
204(h).
    Q-3. What is an ``applicable pension plan'' to which section 4980F 
and section 204(h) apply?
    A-3. (a) In general. Section 4980F and section 204(h) apply to an 
applicable pension plan. For purposes of section 4980F, an applicable 
pension plan means a defined benefit plan qualifying under section 
401(a) or 403(a) of the Internal Revenue Code, or an individual account 
plan that is subject to the funding standards of section 412 of the 
Internal Revenue Code. For purposes of section 204(h), an applicable 
pension plan means a defined benefit plan that is subject to part 2 of 
subtitle B of title I of ERISA, or an individual account plan that is

[[Page 346]]

subject to such part 2 and to the funding standards of section 412 of 
the Internal Revenue Code. Accordingly, individual account plans that 
are not subject to the funding standards of section 412 of the Internal 
Revenue Code, such as profit-sharing and stock bonus plans and contracts 
under section 403(b) of the Internal Revenue Code, are not applicable 
pension plans to which section 4980F or section 204(h) apply. Similarly, 
a defined benefit plan that neither qualifies under section 401(a) or 
403(a) of the Internal Revenue Code nor is subject to part 2 of subtitle 
B of title I of ERISA is not an applicable pension plan. Further, 
neither a governmental plan (within the meaning of section 414(d) of the 
Internal Revenue Code), nor a church plan (within the meaning of section 
414(e) of the Internal Revenue Code) with respect to which no election 
has been made under section 410(d) of the Internal Revenue Code is an 
applicable pension plan.
    (b) Section 204(h) notice not required for small plans covering no 
employees. Section 204(h) notice is not required for a plan under which 
no employees are participants covered under the plan, as described in 
Sec. 2510.3-3(b) of the Department of Labor regulations, and which has 
fewer than 100 participants.
    Q-4. What is ``section 204(h) notice'' and what is a ``section 
204(h) amendment''?
    A-4. (a) Section 204(h) notice is notice that complies with section 
4980F(e) of the Internal Revenue Code, section 204(h)(1) of ERISA, and 
this section.
    (b) A section 204(h) amendment is an amendment for which section 
204(h) notice is required under this section.
    Q-5. For which amendments is section 204(h) notice required?
    A-5. (a) Significant reduction in the rate of future benefit 
accrual. Section 204(h) notice is required for an amendment to an 
applicable pension plan that provides for a significant reduction in the 
rate of future benefit accrual.
    (b) Early retirement benefits and retirement-type subsidies. Section 
204(h) notice is also required for an amendment to an applicable pension 
plan that provides for the significant reduction of an early retirement 
benefit or retirement-type subsidy. For purposes of this section, early 
retirement benefit and retirement-type subsidy mean early retirement 
benefits and retirement-type subsidies within the meaning of section 
411(d)(6)(B)(i).
    (c) Elimination or cessation of benefits. For purposes of this 
section, the terms reduce or reduction include eliminate or cease or 
elimination or cessation.
    (d) Delegation of authority to Commissioner. The Commissioner may 
provide in revenue rulings, notices, or other guidance published in the 
Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter) that 
section 204(h) notice need not be provided for plan amendments otherwise 
described in paragraph (a) or (b) of this Q&A-5 that the Commissioner 
determines to be necessary or appropriate, as a result of changes in the 
law, to maintain compliance with the requirements of the Internal 
Revenue Code (including requirements for tax qualification), ERISA, or 
other applicable federal law.
    Q-6. What is an amendment that reduces the rate of future benefit 
accrual or reduces an early retirement benefit or retirement-type 
subsidy for purposes of determining whether section 204(h) notice is 
required?
    A-6. (a) In general. For purposes of determining whether section 
204(h) notice is required, an amendment reduces the rate of future 
benefit accrual or reduces an early retirement benefit or retirement-
type subsidy only as provided in paragraph (b) or (c) of this Q&A-6.
    (b) Reduction in rate of future benefit accrual--(1) Defined benefit 
plans. For purposes of section 4980F and section 204(h), an amendment to 
a defined benefit plan reduces the rate of future benefit accrual only 
if it is reasonably expected that the amendment will reduce the amount 
of the future annual benefit commencing at normal retirement age (or at 
actual retirement age, if later) for benefits accruing for a year. For 
this purpose, the annual benefit commencing at normal retirement age is 
the benefit payable in the form in which the terms of the plan express 
the accrued benefit (or, in the case of a plan in which the accrued 
benefit is not expressed in the form of an annual benefit commencing at 
normal retirement age, the benefit payable in the form of a single life 
annuity commencing at

[[Page 347]]

normal retirement age that is the actuarial equivalent of the accrued 
benefit expressed under the terms of the plan, as determined in 
accordance with section 411(c)(3) of the Internal Revenue Code).
    (2) Individual account plans. For purposes of section 4980F and 
section 204(h), an amendment to an individual account plan reduces the 
rate of future benefit accrual only if it is reasonably expected that 
the amendment will reduce the amount of contributions or forfeitures 
allocated for any future year. Changes in the investments or investment 
options under an individual account plan are not taken into account for 
this purpose.
    (3) Determination of rate of future benefit accrual. The rate of 
future benefit accrual for purposes of this paragraph (b) is determined 
without regard to optional forms of benefit within the meaning of Sec. 
1.411(d)-4, Q&A-1(b) of this chapter (other than the annual benefit 
described in paragraph (b)(1) of this Q&A-6). The rate of future benefit 
accrual is also determined without regard to ancillary benefits and 
other rights or features as defined in Sec. 1.401(a)(4)-4(e) of this 
chapter.
    (c) Reduction of early retirement benefits or retirement-type 
subsidies. For purposes of section 4980F and section 204(h), an 
amendment reduces an early retirement benefit or retirement-type subsidy 
only if it is reasonably expected that the amendment will eliminate or 
reduce an early retirement benefit or retirement-type subsidy.
    Q-7. What plan provisions are taken into account in determining 
whether an amendment is a section 204(h) amendment?
    A-7. (a) Plan provisions taken into account---(1) In general. All 
plan provisions that may affect the rate of future benefit accrual, 
early retirement benefits, or retirement-type subsidies of participants 
or alternate payees must be taken into account in determining whether an 
amendment is a section 204(h) amendment. For example, plan provisions 
that may affect the rate of future benefit accrual include the dollar 
amount or percentage of compensation on which benefit accruals are 
based; the definition of service or compensation taken into account in 
determining an employee's benefit accrual; the method of determining 
average compensation for calculating benefit accruals; the definition of 
normal retirement age in a defined benefit plan; the exclusion of 
current participants from future participation; benefit offset 
provisions; minimum benefit provisions; the formula for determining the 
amount of contributions and forfeitures allocated to participants' 
accounts in an individual account plan; in the case of a plan using 
permitted disparity under section 401(l) of the Internal Revenue Code, 
the amount of disparity between the excess benefit percentage or excess 
contribution percentage and the base benefit percentage or base 
contribution percentage (all as defined in section 401(l) of the 
Internal Revenue Code); and the actuarial assumptions used to determine 
contributions under a target benefit plan (as defined in Sec. 
1.401(a)(4)-8(b)(3)(i) of this chapter). Plan provisions that may affect 
early retirement benefits or retirement-type subsidies include the right 
to receive payment of benefits after severance from employment and 
before normal retirement age and actuarial factors used in determining 
optional forms for distribution of retirement benefits.
    (2) Provisions incorporated by reference in plan. If all or a part 
of a plan's rate of future benefit accrual, or an early retirement 
benefit or retirement-type subsidy provided under the plan, depends on 
provisions in another document that are referenced in the plan document, 
a change in the provisions of the other document is an amendment of the 
plan.
    (b) Plan provisions not taken into account--(1) In general. Plan 
provisions that do not affect the rate of future benefit accrual of 
participants or alternate payees are not taken into account in 
determining whether there has been a reduction in the rate of future 
benefit accrual.
    (2) Interaction with section 411(d)(6). Any benefit that is not a 
section 411(d)(6) protected benefit as described in Sec. Sec. 1.411(d)-
3(g)(14) and 1.411(d)-4, Q&A-1(d) of this chapter, or that is a section 
411(d)(6) protected benefit that may be eliminated or reduced as 
permitted under Sec. 1.411(d)-3(c), (d), or (f),

[[Page 348]]

or under Sec. 1.411(d)-4, Q&A-2(a)(2), (a)(3), (b)(1), or (b)(2)(ii) 
through (b)(2)(xi) of this chapter, is not taken into account in 
determining whether an amendment is a section 204(h) amendment. Thus, 
for example, provisions relating to the right to make after-tax 
deferrals are not taken into account.
    (c) Examples. The following examples illustrate the rules in this 
Q&A-7:

    Example 1. (i) Facts. A defined benefit plan provides a normal 
retirement benefit equal to 50% of highest 5-year average pay multiplied 
by a fraction (not in excess of one), the numerator of which equals the 
number of years of participation in the plan and the denominator of 
which is 20. A plan amendment is adopted that changes the numerator or 
denominator of that fraction.
    (ii) Conclusion. The plan amendment must be taken into account in 
determining whether there has been a reduction in the rate of future 
benefit accrual.
    Example 2. (i) Facts. Plan C is a multiemployer defined benefit plan 
subject to several collective bargaining agreements. The specific 
benefit formula under Plan C that applies to an employee depends on the 
hourly rate of contribution of the employee's employer, which is set 
forth in the provisions of the collective bargaining agreements that are 
referenced in the Plan C document. Collective Bargaining Agreement A 
between Employer B and the union representing employees of Employer B is 
renegotiated to provide that the hourly contribution rate for an 
employee of B who is subject to the Collective Bargaining Agreement A 
will decrease. That decrease will result in a decrease in the rate of 
future benefit accrual for employees of B.
    (ii) Conclusion. Under paragraph (a)(2) of this Q&A-7, the change to 
Collective Bargaining Agreement A is a plan amendment that is a section 
204(h) amendment if the reduction in the rate of future benefit accrual 
is significant.

    Q-8. What is the basic principle used in determining whether a 
reduction in the rate of future benefit accrual or a reduction in an 
early retirement benefit or retirement-type subsidy is significant for 
purposes of section 4980F and section 204(h)?
    A-8. (a) General rule. Whether an amendment reducing the rate of 
future benefit accrual or eliminating or reducing an early retirement 
benefit or retirement-type subsidy provides for a reduction that is 
significant for purposes of section 4980F (and section 204(h) of ERISA) 
is determined based on reasonable expectations taking into account the 
relevant facts and circumstances at the time the amendment is adopted, 
or, if earlier, at the effective date of the amendment.
    (b) Application for determining significant reduction in the rate of 
future benefit accrual. For a defined benefit plan, the determination of 
whether an amendment provides for a significant reduction in the rate of 
future benefit accrual is made by comparing the amount of the annual 
benefit commencing at normal retirement age (or at actual retirement 
age, if later), as determined under Q&A-6(b)(1) of this section, under 
the terms of the plan as amended with the amount of the annual benefit 
commencing at normal retirement age (or at actual retirement age, if 
later), as determined under Q&A-6(b)(1) of this section, under the terms 
of the plan prior to amendment. For an individual account plan, the 
determination of whether an amendment provides for a significant 
reduction in the rate of future benefit accrual is made in accordance 
with Q&A-6(b)(2) of this section by comparing the amounts to be 
allocated in the future to participants' accounts under the terms of the 
plan as amended with the amounts to be allocated in the future to 
participants' accounts under the terms of the plan prior to amendment. 
An amendment to convert a money purchase pension plan to a profit-
sharing or other individual account plan that is not subject to section 
412 of the Internal Revenue Code is, in all cases, deemed to be an 
amendment that provides for a significant reduction in the rate of 
future benefit accrual.
    (c) Application to certain amendments reducing early retirement 
benefits or retirement-type subsidies. Section 204(h) notice is not 
required for an amendment that reduces an early retirement benefit or 
retirement-type subsidy if the amendment is permitted under the third 
sentence of section 411(d)(6)(B) of the Internal Revenue Code and 
paragraphs (c), (d), and (f) of Sec. 1.411(d)-3 of this chapter 
(relating to the elimination or reduction of benefits or subsidies which 
create significant burdens or complexities for the plan and plan

[[Page 349]]

participants unless the amendment adversely affects the rights of any 
participant in a more than de minimis manner). However, in determining 
whether an amendment reducing a retirement-type subsidy constitutes a 
significant reduction because it reduces a retirement-type subsidy as 
permitted under Sec. 1.411(d)-3(e)(6) of this chapter, the amendment is 
treated in the same manner as an amendment that limits the retirement-
type subsidy to benefits that accrue before the applicable amendment 
date (as defined at Sec. 1.411(d)-3(g)(4) of this chapter) with respect 
to each participant or alternate payee to whom the reduction is 
reasonably expected to apply.
    (d) Plan amendments reflecting a change in statutorily mandated 
minimum present value rules. If a defined benefit plan offers a 
distribution to which the minimum present value rules of section 
417(e)(3) apply (other than a payment to which section 411(a)(13)(A) 
applies) and the plan is amended to reflect the changes to the 
applicable interest rate and applicable mortality table in section 
417(e)(3) made by the Pension Protection Act of 2006, Public Law 109-780 
(120 Stat. 780) (PPA '06) (and no change is made in the dates on which 
the payment will be made), no section 204(h) notice is required to be 
provided.
    (e) Examples. The following examples illustrate the rules in this 
Q&A-8:

    Example 1. (i) Facts. Pension Plan A is a defined benefit plan that 
provides a rate of benefit accrual of 1% of highest-5 years pay 
multiplied by years of service, payable annually for life commencing at 
normal retirement age (or at actual retirement age, if later). An 
amendment to Plan A is adopted on August 1, 2009, effective January 1, 
2010, to provide that any participant who separates from service after 
December 31, 2009, and before January 1, 2015, will have the same number 
of years of service he or she would have had if his or her service 
continued to December 31, 2014.
    (ii) Conclusion. In this example, the effective date of the plan 
amendment is January 1, 2010. While the amendment will result in a 
reduction in the annual rate of future benefit accrual from 2011 through 
2014 (because, under the amendment, benefits based upon an additional 5 
years of service accrue on January 1, 2010, and no additional service is 
credited after January 1, 2010 until January 1, 2015), the amendment 
does not result in a reduction that is significant because the amount of 
the annual benefit commencing at normal retirement age (or at actual 
retirement age, if later) under the terms of the plan as amended is not 
under any conditions less than the amount of the annual benefit 
commencing at normal retirement age (or at actual retirement age, if 
later) to which any participant would have been entitled under the terms 
of the plan had the amendment not been made.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that the 2009 amendment does not alter the plan provisions relating to a 
participant's number of years of service, but instead amends the plan's 
provisions relating to early retirement benefits. Before the amendment, 
the plan provides for distributions before normal retirement age to be 
actuarially reduced, but, if a participant retires after attainment of 
age 55 and completion of 10 years of service, the applicable early 
retirement reduction factor is 3% per year for the years between the 
ages 65 and 62 and 6% per year for the ages from 62 to 55. The amendment 
changes these provisions so that an actuarial reduction applies in all 
cases, but, in accordance with section 411(d)(6)(B), provides that no 
participant's early retirement benefit will be less than the amount 
provided under the plan as in effect on December 31, 2009 with respect 
to service before January 1, 2010. For participant X, the reduction is 
significant.
    (ii) Conclusion. The amendment will result in a reduction in a 
retirement-type subsidy provided under Plan A (i.e., Plan A's early 
retirement subsidy). Section 204(h) notice must be provided to 
participant X and any other participant for whom the reduction is 
significant and the notice must be provided at least 45 days before 
January 1, 2010 (or by such other date as may apply under Q&A-9 of this 
section).
    Example 3. (i) Facts. The facts are the same as in Example 2, except 
that, for participant X, the change does not go into effect for any 
annuity commencement date before January 1, 2011. Participant X 
continues employment through January 1, 2011.
    (ii) Conclusion. The conclusion is the same as in Example 2. Taking 
into account the rule in the second sentence of Q&A-8(c) of this 
section, the reduction that occurs for participant X on January 1, 2011, 
is treated as the same reduction that occurs under Example 2. 
Accordingly, assuming that the reduction is significant, section 204(h) 
notice must be provided to participant X at least 45 days before the 
January 1, 2010 effective date of the amendment (or by such other date 
as may apply under Q&A-9 of this section).

    Q-9. When must section 204(h) notice be provided?

[[Page 350]]

    A-9. (a) 45-day general rule. Except as otherwise provided in this 
Q&A-9, section 204(h) notice must be provided at least 45 days before 
the effective date of any section 204(h) amendment. See paragraph (e) of 
this Q&A-9 for special rules for amendments permitting participant 
choice.
    (b) 15-day rule for small plans. Except for amendments described in 
paragraphs (d)(2) and (g) of this Q&A-9, section 204(h) notice must be 
provided at least 15 days before the effective date of any section 
204(h) amendment in the case of a small plan. For purposes of this 
section, a small plan is a plan that the plan administrator reasonably 
expects to have, on the effective date of the section 204(h) amendment, 
fewer than 100 participants who have an accrued benefit under the plan.
    (c) 15-day rule for multiemployer plans. Except for amendments 
described in paragraphs (d)(2) and (g) of this Q&A-9, section 204(h) 
notice must be provided at least 15 days before the effective date of 
any section 204(h) amendment in the case of a multiemployer plan. For 
purposes of this section, a multiemployer plan means a multiemployer 
plan as defined in section 414(f) of the Internal Revenue Code.
    (d) Special timing rule for business transactions--(1) 15-day rule 
for section 204(h) amendment in connection with an acquisition or 
disposition. Except for amendments described in paragraphs (d)(2) and 
(g) of this Q&A-9, if a section 204(h) amendment is adopted in 
connection with an acquisition or disposition, section 204(h) notice 
must be provided at least 15 days before the effective date of the 
section 204(h) amendment.
    (2) Later notice permitted for a section 204(h) amendment 
significantly reducing early retirement benefit or retirement-type 
subsidies in connection with certain plan transfers, mergers, or 
consolidations. If a section 204(h) amendment is adopted with respect to 
liabilities that are transferred to another plan in connection with a 
transfer, merger, or consolidation of assets or liabilities as described 
in section 414(l) of the Internal Revenue Code and Sec. 1.414(l)-1 of 
this chapter, the amendment is adopted in connection with an acquisition 
or disposition, and the amendment significantly reduces an early 
retirement benefit or retirement-type subsidy, but does not 
significantly reduce the rate of future benefit accrual, then section 
204(h) notice must be provided no later than 30 days after the effective 
date of the section 204(h) amendment.
    (3) Definition of acquisition or disposition. For purposes of this 
paragraph (d), see Sec. 1.410(b)-2(f) of this chapter for the 
definition of acquisition or disposition.
    (e) Timing rule for amendments permitting participant choice. In 
general, section 204(h) notice of a section 204(h) amendment that 
provides applicable individuals with a choice between the old and the 
new benefit formulas (as described in Q&A-12 of this section) must be 
provided in accordance with the time period applicable under paragraphs 
(a) through (d) of this Q&A-9. See Q&A-12 of this section for additional 
guidance regarding section 204(h) notice in connection with participant 
choice.
    (f) Special timing rule for certain plans maintained by commercial 
airlines. See section 402 of PPA '06 for a special rule that applies to 
certain plans maintained by an employer that is a commercial passenger 
airline or the principal business of which is providing catering 
services to a commercial passenger airline. Under this special rule, 
section 204(h) notice must be provided at least 15 days before the 
effective date of the amendment.
    (g) Special timing rules relating to certain section 204(h) 
amendments that reduce section 411(d)(6) protected benefits--(1) Plan 
amendments permitted to reduce prior accruals. This paragraph (g) 
generally provides special rules with respect to a plan amendment that 
would not violate section 411(d)(6) even if the amendment were to reduce 
section 411(d)(6) protected benefits, which are limited to accrued 
benefits that are attributable to service before the applicable 
amendment date. For example, this paragraph (g) applies to amendments 
that are permitted to be effective retroactively under section 412(d)(2) 
of the Code (section 412(c)(8) for plan years beginning before January 
1, 2008), section 418D of the Code, section 418E of the Code, section 
4281 of ERISA, or section 1107 of PPA '06. See, generally, Sec. 
1.411(d)-3(a)(1).

[[Page 351]]

    (2) General timing rule for amendments to which this paragraph (g) 
applies. For an amendment to which this paragraph (g) applies, the 
amendment is effective on the first date on which the plan is operated 
as if the amendment were in effect. Thus, except as otherwise provided 
in this paragraph (g), a section 204(h) notice for an amendment to which 
paragraph (a) of this section applies that is adopted after the 
effective date of the amendment must be provided, with respect to any 
applicable individual, at least 45 days before (or such other date as 
may apply under paragraph (b), (c), (d), or (f) of this Q&A-9) the date 
the amendment is put into operational effect.
    (3) Special rules for section 204(h) notices provided in connection 
with other disclosure requirements--(i) In general. Notwithstanding the 
requirements in this Q&A-9 and Q&A-11 of this section, if a plan 
provides one of the notices in paragraph (g)(3)(ii) of this Q&A-9, in 
accordance with the applicable timing and content rules for such notice, 
the plan is treated as timely providing a section 204(h) notice with 
respect to a section 204(h) amendment.
    (ii) Notice requirements. The notices in this paragraph (g)(3)(ii) 
are--
    (A) A notice required under any revenue ruling, notice, or other 
guidance published under the authority of the Commissioner in the 
Internal Revenue Bulletin to affected parties in connection with a 
retroactive plan amendment described in section 412(d)(2) (section 
412(c)(8) for plan years beginning before January 1, 2008);
    (B) A notice required under section 101(j) of ERISA if an amendment 
is adopted to comply with the benefit limitation requirements of section 
206(g) of ERISA (section 436 of the Code);
    (C) A notice required under section 432(b)(3)(D) of the Code for an 
amendment adopted to comply with the benefit restrictions under section 
432(f)(2);
    (D) A notice required under section 418D, or section 4244A(b) of 
ERISA, for an amendment that reduces or eliminates accrued benefits 
attributable to employer contributions with respect to a multiemployer 
plan in reorganization;
    (E) A notice required under section 418E, or section 4245(e) of 
ERISA, relating to the effects of the insolvency status for a 
multiemployer plan; and
    (F) A notice required under section 4281 of ERISA for an amendment 
of a multiemployer plan reducing benefits pursuant to section 4281(c) of 
ERISA.
    (4) Delegation of authority to Commissioner. The Commissioner may 
provide special rules under section 4980F, in revenue rulings, notices, 
or other guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter), that the Commissioner determines 
to be necessary or appropriate with respect to a section 204(h) 
amendment--
    (A) That applies to benefits accrued before the applicable amendment 
date but that does not violate section 411(d)(6); or
    (B) For which there is a required notice relating to a reduction in 
benefits and such notice has timing and content requirements similar to 
a section 204(h) notice with respect to a significant reduction in the 
rate of future benefit accruals.
    Q-10. To whom must section 204(h) notice be provided?
    A-10. (a) In general. Section 204(h) notice must be provided to each 
applicable individual, to each employee organization representing 
participants who are applicable individuals, and, for plan years 
beginning after December 31, 2007, to each employer that has an 
obligation to contribute (within the meaning of section 4212(a) of 
ERISA) to a multiemployer plan. A special rule is provided in paragraph 
(d) of this Q&A-10.
    (b) Applicable individual. Applicable individual means each 
participant in the plan, and any alternate payee, whose rate of future 
benefit accrual under the plan is reasonably expected to be 
significantly reduced, or for whom an early retirement benefit or 
retirement-type subsidy under the plan may reasonably be expected to be 
significantly reduced, by the section 204(h) amendment. The 
determination is made with respect to individuals who are reasonably 
expected to be participants or alternate payees in the plan at the 
effective date of the section 204(h) amendment.

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    (c) Alternate payee. Alternate payee means a beneficiary who is an 
alternate payee (within the meaning of section 414(p)(8) of the Internal 
Revenue Code) under an applicable qualified domestic relations order 
(within the meaning of section 414(p)(1)(A) of the Internal Revenue 
Code).
    (d) Designees. Section 204(h) notice may be provided to a person 
designated in writing by an applicable individual or by an employee 
organization representing participants who are applicable individuals, 
instead of being provided to that applicable individual or employee 
organization. Any designation of a representative made through an 
electronic method that satisfies standards similar to those of Q&A-
13(c)(1) of this section satisfies the requirement that a designation be 
in writing.
    (e) Facts and circumstances test. Whether a participant or alternate 
payee is an applicable individual is determined on a typical business 
day that is reasonably proximate to the time the section 204(h) notice 
is provided (or at the latest date for providing section 204(h) notice, 
if earlier), based on all relevant facts and circumstances.
    (f) Examples. The following examples illustrate the rules in this 
Q&A-10:

    Example 1. (i) Facts. A defined benefit plan requires an individual 
to complete 1 year of service to become a participant who can accrue 
benefits, and participants cease to accrue benefits under the plan at 
severance from employment with the employer. There are no alternate 
payees and employees are not represented by an employee organization. On 
November 18, 2004, the plan is amended effective as of January 1, 2005 
to reduce significantly the rate of future benefit accrual. Section 
204(h) notice is provided on November 1, 2004.
    (ii) Conclusion. Section 204(h) notice is only required to be 
provided to individuals who, based on the facts and circumstances on 
November 1, 2004, are reasonably expected to have completed at least 1 
year of service and to be employed by the employer on January 1, 2005.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that the sole effect of the plan amendment is to alter the pre-amendment 
plan provisions under which benefits payable to an employee who retires 
after 20 or more years of service are unreduced for commencement before 
normal retirement age. The amendment requires 30 or more years of 
service in order for benefits commencing before normal retirement age to 
be unreduced, but the amendment only applies for future benefit 
accruals.
    (ii) Conclusion. Section 204(h) notice is only required to be 
provided to individuals who, on January 1, 2005, have completed at least 
1 year of service but less than 30 years of service, are employed by the 
employer, have not attained normal retirement age, and will have 
completed 20 or more years of service before normal retirement age if 
their employment continues to normal retirement age.
    Example 3. (i) Facts. A plan is amended to reduce significantly the 
rate of future benefit accrual for all current employees who are 
participants. Based on the facts and circumstances, it is reasonable to 
expect that the amendment will not reduce the rate of future benefit 
accrual of former employees who are currently receiving benefits or of 
former employees who are entitled to deferred vested benefits.
    (ii) Conclusion. The plan administrator is not required to provide 
section 204(h) notice to any former employees.
    Example 4. (i) Facts. The facts are the same as in Example 3, except 
that the plan covers two groups of alternate payees. The alternate 
payees in the first group are entitled to a certain percentage or 
portion of the former spouse's accrued benefit and, for this purpose, 
the accrued benefit is determined at the time the former spouse begins 
receiving retirement benefits under the plan. The alternate payees in 
the second group are entitled to a certain percentage or portion of the 
former spouse's accrued benefit and, for this purpose, the accrued 
benefit was determined at the time the qualified domestic relations 
order was issued by the court.
    (ii) Conclusion. It is reasonable to expect that the benefits to be 
received by the second group of alternate payees will not be affected by 
any reduction in a former spouse's rate of future benefit accrual. 
Accordingly, the plan administrator is not required to provide section 
204(h) notice to the alternate payees in the second group.
    Example 5. (i) Facts. A plan covers hourly employees and salaried 
employees. The plan provides the same rate of benefit accrual for both 
groups. The employer amends the plan to reduce significantly the rate of 
future benefit accrual of the salaried employees only. At that time, it 
is reasonable to expect that only a small percentage of hourly employees 
will become salaried in the future.
    (ii) Conclusion. The plan administrator is not required to provide 
section 204(h) notice to the participants who are currently hourly 
employees.
    Example 6. (i) Facts. A plan covers employees in Division M and 
employees in Division N. The plan provides the same rate of benefit 
accrual for both groups. The employer

[[Page 353]]

amends the plan to reduce significantly the rate of future benefit 
accrual of employees in Division M. At that time, it is reasonable to 
expect that in the future only a small percentage of employees in 
Division N will be transferred to Division M.
    (ii) Conclusion. The plan administrator is not required to provide 
section 204(h) notice to the participants who are employees in Division 
N.
    Example 7. (i) Facts. The facts are the same facts as in Example 6, 
except that at the time the amendment is adopted, it is expected that 
thereafter Division N will be merged into Division M in connection with 
a corporate reorganization (and the employees in Division N will become 
subject to the plan's amended benefit formula applicable to the 
employees in Division M).
    (ii) Conclusion. In this case, the plan administrator must provide 
section 204(h) notice to the participants who are employees in Division 
M and to the participants who are employees in Division N.
    Example 8. (i) Facts. A plan is amended to reduce significantly the 
rate of future benefit accrual for all current employees who are 
participants. The plan amendment will be effective on January 1, 2004. 
The plan will provide the notice to applicable individuals on October 
31, 2003. In determining which current employees are applicable 
individuals, the plan administrator determines that October 1, 2003, is 
a typical business day that is reasonably proximate to the time the 
section 204(h) notice is provided.
    (ii) Conclusion. In this case, October 1, 2003 is a typical business 
day that satisfies the requirements of Q&A-10(e) of this section.

    Q-11. What information is required to be provided in a section 
204(h) notice?
    A-11. (a) Explanation of notice requirements--(1) In general. 
Section 204(h) notice must include sufficient information to allow 
applicable individuals to understand the effect of the plan amendment. 
In order to satisfy this rule, a plan administrator providing section 
204(h) notice must generally satisfy paragraphs (a)(2), (a)(3), (a)(4), 
(a)(5), and (a)(6) of this Q&A-11. See paragraph (g)(3) of Q&A-9 of this 
section for special rules relating to section 204(h) notices provided in 
connection with certain other written notices. See also paragraph (g)(4) 
of Q&A-9 of this section for a delegation of authority to the 
Commissioner to provide special rules.
    (2) Information in section 204(h) notice. The information in a 
section 204(h) notice must be written in a manner calculated to be 
understood by the average plan participant and to apprise the applicable 
individual of the significance of the notice.
    (3) Required narrative description of amendment--(i) Reduction in 
rate of future benefit accrual. In the case of an amendment reducing the 
rate of future benefit accrual, the notice must include a description of 
the benefit or allocation formula prior to the amendment, a description 
of the benefit or allocation formula under the plan as amended, and the 
effective date of the amendment.
    (ii) Reduction in early retirement benefit or retirement-type 
subsidy. In the case of an amendment that reduces an early retirement 
benefit or retirement-type subsidy (other than as a result of an 
amendment reducing the rate of future benefit accrual), the notice must 
describe how the early retirement benefit or retirement-type subsidy is 
calculated from the accrued benefit before the amendment, how the early 
retirement benefit or retirement-type subsidy is calculated from the 
accrued benefit after the amendment, and the effective date of the 
amendment. For example, if, for a plan with a normal retirement age of 
65, the change is from an unreduced normal retirement benefit at age 55 
to an unreduced normal retirement benefit at age 60 for benefits accrued 
in the future, with an actuarial reduction to apply for benefits accrued 
in the future to the extent that the early retirement benefit begins 
before age 60, the notice must state the change and specify the factors 
that apply in calculating the actuarial reduction (for example, a 5% per 
year reduction applies for early retirement before age 60).
    (4) Sufficient information to determine the approximate magnitude of 
reduction--(i) General rule. (A) Section 204(h) notice must include 
sufficient information for each applicable individual to determine the 
approximate magnitude of the expected reduction for that individual. 
Thus, in any case in which it is not reasonable to expect that the 
approximate magnitude of the reduction for each applicable individual 
will be reasonably apparent from the description of the amendment 
provided in accordance with paragraph (a)(3) of this

[[Page 354]]

Q&A-11, further information is required. The further information may be 
provided by furnishing additional narrative information or in other 
information that satisfies this paragraph of this section.
    (B) To the extent any expected reduction is not uniformly applicable 
to all participants, the notice must either identify the general classes 
of participants to whom the reduction is expected to apply, or by some 
other method include sufficient information to allow each applicable 
individual receiving the notice to determine which reductions are 
expected to apply to that individual.
    (ii) Illustrative examples--(A) Requirement generally. The 
requirement to include sufficient information for each applicable 
individual to determine the approximate magnitude of the expected 
reduction for that individual under (a)(4)(i)(A) of this Q&A-11 is 
deemed satisfied if the notice includes one or more illustrative 
examples showing the approximate magnitude of the reduction in the 
examples, as provided in this paragraph (a)(4)(ii). Illustrative 
examples are in any event required to be provided for any change from a 
traditional defined benefit formula to a cash balance formula or a 
change that results in a period of time during which there are no 
accruals (or minimal accruals) with regard to normal retirement benefits 
or an early retirement subsidy (a wear-away period).
    (B) Examples must bound the range of reductions. Where an amendment 
results in reductions that vary (either among participants, as would 
occur for an amendment converting a traditional defined benefit formula 
to a cash balance formula, or over time as to any individual 
participant, as would occur for an amendment that results in a wear-away 
period), the illustrative example(s) provided in accordance with this 
paragraph (a)(4)(ii) must show the approximate range of the reductions. 
However, any reductions that are likely to occur in only a de minimis 
number of cases are not required to be taken into account in determining 
the range of the reductions if a narrative statement is included to that 
effect and examples are provided that show the approximate range of the 
reductions in other cases. Amendments for which the maximum reduction 
occurs under identifiable circumstances, with proportionately smaller 
reductions in other cases, may be illustrated by one example 
illustrating the maximum reduction, with a statement that smaller 
reductions also occur. Further, assuming that the reduction varies from 
small to large depending on service or other factors, two illustrative 
examples may be provided showing the smallest likely reduction and the 
largest likely reduction.
    (C) Assumptions used in examples. The examples provided under this 
paragraph (a)(4)(ii) are not required to be based on any particular form 
of payment (such as a life annuity or a single sum), but may be based on 
whatever form appropriately illustrates the reduction. The examples 
generally may be based on any reasonable assumptions (for example, 
assumptions relating to the representative participant's age, years of 
service, and compensation, along with any interest rate and mortality 
table used in the illustrations, as well as salary scale assumptions 
used in the illustrations for amendments that alter the compensation 
taken into account under the plan), but the section 204(h) notice must 
identify those assumptions. However, if a plan's benefit provisions 
include a factor that varies over time (such as a variable interest 
rate), the determination of whether an amendment is reasonably expected 
to result in a wear-away period must be based on the value of the factor 
applicable under the plan at a time that is reasonably close to the date 
section 204(h) notice is provided, and any wear-away period that is 
solely a result of a future change in the variable factor may be 
disregarded. For example, to determine whether a wear-away occurs as a 
result of a section 204(h) amendment that converts a defined benefit 
plan to a cash balance pension plan that will credit interest based on a 
variable interest factor specified in the plan, the future interest 
credits must be projected based on the interest rate applicable under 
the variable factor at the time section 204(h) notice is provided.

[[Page 355]]

    (D) Individual statements. This paragraph (a)(4)(ii) may be 
satisfied by providing a statement to each applicable individual 
projecting what that individual's future benefits are reasonably 
expected to be at various future dates and what that individual's future 
benefits would have been under the terms of the plan as in effect before 
the section 204(h) amendment, provided that the statement includes the 
same information required for examples under paragraphs (a)(4)(ii)(A) 
through (C) of this Q&A-11, including showing the approximate range of 
the reductions for the individual if the reductions vary over time and 
identification of the assumptions used in the projections.
    (5) No false or misleading information. A section 204(h) notice may 
not include materially false or misleading information (or omit 
information so as to cause the information provided to be misleading).
    (6) Additional information when reduction not uniform--(i) In 
general. If an amendment by its terms affects different classes of 
participants differently (e.g., one new benefit formula will apply to 
Division A and another to Division B), then the requirements of 
paragraph (a) of this Q&A-11 apply separately with respect to each such 
general class of participants. In addition, the notice must include 
sufficient information to enable an applicable individual who is a 
participant to understand which class he or she is a member of.
    (ii) Option for different section 204(h) notices. If a section 
204(h) amendment affects different classes of applicable individuals 
differently, the plan administrator may provide to differently affected 
classes of applicable individuals a section 204(h) notice appropriate to 
those individuals. Such section 204(h) notice may omit information that 
does not apply to the applicable individuals to whom it is furnished, 
but must identify the class or classes of applicable individuals to whom 
it is provided.
    (b) Examples. The following examples illustrate the requirements 
paragraph (a) of this Q&A-11. In each example, it is assumed that the 
actual notice provided is written in a manner calculated to be 
understood by the average plan participant and to apprise the applicable 
individual of the significance of the notice in accordance with 
paragraph (a)(2) of this Q&A-11. The examples are as follows:

    Example 1. (i) Facts. Plan A provides that a participant is entitled 
to a normal retirement benefit of 2% of the participant's average pay 
over the 3 consecutive years for which the average is the highest 
(highest average pay) multiplied by years of service. Plan A is amended 
to provide that, effective January 1, 2004, the normal retirement 
benefit will be 2% of the participant's highest average pay multiplied 
by years of service before the effective date, plus 1% of the 
participant's highest average pay multiplied by years of service after 
the effective date. The plan administrator provides notice that states: 
``Under the Plan's current benefit formula, a participant's normal 
retirement benefit is 2% of the participant's average pay over the 3 
consecutive years for which the average is the highest multiplied by the 
participant's years of service. This formula is being changed by a plan 
amendment. Under the Plan as amended, a participant's normal retirement 
benefit will be the sum of 2% of the participant's average pay over the 
3 consecutive years for which the average is the highest multiplied by 
years of service before the January 1, 2004 effective date, plus 1% of 
the participant's average pay over the 3 consecutive years for which the 
average is the highest multiplied by the participant's years of service 
after December 31, 2003. This change is effective on January 1, 2004.'' 
The notice does not contain any additional information.
    (ii) Conclusion. The notice satisfies the requirements of paragraph 
(a) of this Q&A-11.
    Example 2. (i) Facts. Plan B provides that a participant is entitled 
to a normal retirement benefit at age 64 of 2.2% of the participant's 
career average pay multiplied by years of service. Plan B is amended to 
cease all accruals, effective January 1, 2004. The plan administrator 
provides notice that includes a description of the old benefit formula, 
a statement that, after December 31, 2003, no participant will earn any 
further accruals, and the effective date of the amendment. The notice 
does not contain any additional information.
    (ii) Conclusion. The notice satisfies the requirements of paragraph 
(a) of this Q&A-11.
    Example 3. (i) Facts. Plan C provides that a participant is entitled 
to a normal retirement benefit at age 65 of 2% of career average 
compensation multiplied by years of service. Plan C is amended to 
provide that the normal retirement benefit will be 1% of average pay 
over the 3 consecutive years for which the average is the highest 
multiplied by years of service. The amendment only applies to accruals 
for years of service after the amendment, so that each employee's 
accrued

[[Page 356]]

benefit is equal to the sum of the benefit accrued as of the effective 
date of the amendment plus the accrued benefit equal to the new formula 
applied to years of service beginning on or after the effective date. 
The plan administrator provides notice that describes the old and new 
benefit formulas and also explains that for an individual whose 
compensation increases over the individual's career such that the 
individual's highest 3-year average exceeds the individual's career 
average, the reduction will be less or there may be no reduction. The 
notice does not contain any additional information.
    (ii) Conclusion. The notice satisfies the requirements of paragraph 
(a) of this Q&A-11.
    Example 4. (i) Facts. (A) Plan D is a defined benefit pension plan 
under which each participant accrues a normal retirement benefit, as a 
life annuity beginning at the normal retirement age of 65, equal to the 
participant's number of years of service multiplied by 1.5 percent 
multiplied by the participant's average pay over the 3 consecutive years 
for which the average is the highest. Plan D provides early retirement 
benefits for former employees beginning at or after age 55 in the form 
of an early retirement annuity that is actuarially equivalent to the 
normal retirement benefit, with the reduction for early commencement 
based on reasonable actuarial assumptions that are specified in Plan D. 
Plan D provides for the suspension of benefits of participants who 
continue in employment beyond normal retirement age, in accordance with 
section 203(a)(3)(B) of ERISA and regulations thereunder issued by the 
Department of Labor. The pension of a participant who retires after age 
65 is calculated under the same normal retirement benefit formula, but 
is based on the participant's service credit and highest 3-year pay at 
the time of late retirement with any appropriate actuarial increases.
    (B) Plan D is amended, effective July 1, 2005, to change the formula 
for all future accruals to a cash balance formula under which the 
opening account balance for each participant on July 1, 2005, is zero, 
hypothetical pay credits equal to 5 percent of pay are credited to the 
account thereafter, and hypothetical interest is credited monthly based 
on the applicable interest rate under section 417(e)(3) of the Internal 
Revenue Code at the beginning of the quarter. Any participant who 
terminates employment with vested benefits can receive an actuarially 
equivalent annuity (based on the same reasonable actuarial assumptions 
that are specified in Plan D) commencing at any time after termination 
of employment and before the plan's normal retirement age of 65. The 
benefit resulting from the hypothetical account balance is in addition 
to the benefit accrued before July 1, 2005 (taking into account only 
service and highest 3-year pay before July 1, 2005), so that it is 
reasonably expected that no wear-away period will result from the 
amendment. The plan administrator expects that, as a general rule, 
depending on future pay increases and future interest rates, the rate of 
future benefit accrual after the conversion is higher for participants 
who accrue benefits before approximately age 50 and after approximately 
age 70, but is lower for participants who accrue benefits between 
approximately age 50 and age 70.
    (C) The plan administrator of Plan D announces the conversion to a 
cash balance formula on May 16, 2005. The announcement is delivered to 
all participants and includes a written notice that describes the old 
formula, the new formula, and the effective date.
    (D) In addition, the notice states that the Plan D formula before 
the conversion provided a normal retirement benefit equal to the product 
of a participant's number of years of service multiplied by 1.5 percent 
multiplied by the participant's average pay over the 3 years for which 
the average is the highest (highest 3-year pay). The notice includes an 
example showing the normal retirement benefit that will be accrued after 
June 30, 2005 for a participant who is age 49 with 10 years of service 
at the time of the conversion. The plan administrator reasonably 
believes that such a participant is representative of the participants 
whose rate of future benefit accrual will be reduced as a result of the 
amendment. The example estimates that, if the participant continues 
employment to age 65, the participant's normal retirement benefit for 
service from age 49 to age 65 will be $657 per month for life. The 
example assumes that the participant's pay is $50,000 at age 49. The 
example states that the estimated $657 monthly pension accrues over the 
16-year period from age 49 to age 65 and that, based on assumed future 
pay increases, this amount annually would be 9.1 percent of the 
participant's highest 3-year pay at age 65, which over the 16 years from 
age 49 to age 65 averages 0.57 percent per year multiplied by the 
participant's highest 3-year pay. The example also states that the sum 
of the monthly annuity accrued before the conversion in the 10-year 
period from age 39 to age 49 plus the $657 monthly annuity estimated to 
be accrued over the 16-year period from age 49 to age 65 is $1,235 and 
that, based on assumed future increases in pay, this would be 17.1 
percent of the participant's highest 3-year pay at age 65, which over 
the employee's career from age 39 to age 65 averages 0.66 percent per 
year multiplied by the participant's highest 3-year pay. The notice also 
includes two other examples with similar information, one of which is 
intended to show the circumstances in which a small reduction may occur 
and the other of which shows the largest reduction that the plan 
administrator thinks is likely to occur. The notice states that the 
estimates are based on the

[[Page 357]]

assumption that pay increases annually after June 30, 2005, at a 4 
percent rate. The notice also specifies that the applicable interest 
rate under section 417(e) for hypothetical interest credits after June 
30, 2005 is assumed to be 6 percent, which is the section 417(e) of the 
Internal Revenue Code applicable interest rate under the plan for 2005.
    (ii) Conclusion. The information in the notice, as described in 
paragraph (i)(C) and (i)(D) of this Example 4, satisfies the 
requirements of paragraph (a)(3) of this Q&A-11 with respect to 
applicable individuals who are participants. The requirements of 
paragraph (a)(4) of this Q&A-11 are satisfied because, as noted in 
paragraph (i)(D) of this Example 4, the notice describes the old formula 
and describes the estimated future accruals under the new formula in 
terms that can be readily compared to the old formula, i.e., the notice 
states that the estimated $657 monthly pension accrued over the 16-year 
period from age 49 to age 65 averages 0.57 percent of the participant's 
highest 3-year pay at age 65. The requirement in paragraph (a)(4)(ii) of 
this Q&A-11 that the examples include sufficient information to be able 
to determine the approximate magnitude of the reduction would also be 
satisfied if the notice instead directly stated the amount of the 
monthly pension that would have accrued over the 16-year period from age 
49 to age 65 under the old formula.
    Example 5. (i) Facts. The facts are the same as in Example 4, except 
that, under the plan as in effect before the amendment, the early 
retirement pension for a participant who terminates employment after age 
55 with at least 20 years of service is equal to the normal retirement 
benefit without reduction from age 65 to age 62 and reduced by only 5 
percent per year for each year before age 62. As a result, early 
retirement benefits for such a participant constitute a retirement-type 
subsidy. The plan as in effect after the amendment provides an early 
retirement benefit equal to the sum of the early retirement benefit 
payable under the plan as in effect before the amendment taking into 
account only service and highest 3-year pay before July 1, 2005, plus an 
early retirement annuity that is actuarially equivalent to the account 
balance for service after June 30, 2005. The notice provided by the plan 
administrator describes the old early retirement annuity, the new early 
retirement annuity, and the effective date. The notice includes an 
estimate of the early retirement annuity payable to the illustrated 
participant for service after the conversion if the participant were to 
retire at age 59 (which the plan administrator believes is a typical 
early retirement age) and elect to begin receiving an immediate early 
retirement annuity. The example states that the normal retirement 
benefit expected to be payable at age 65 as a result of service from age 
49 to age 59 is $434 per month for life beginning at age 65 and that the 
early retirement annuity expected to be payable as a result of service 
from age 49 to age 59 is $270 per month for life beginning at age 59. 
The example states that the monthly early retirement annuity of $270 is 
38 percent less than the monthly normal retirement benefit of $434, 
whereas a 15 percent reduction would have applied under the plan as in 
effect before the amendment. The notice also includes similar 
information for examples that show the smallest and largest reduction 
that the plan administrator thinks is likely to occur in the early 
retirement benefit. The notice also specifies the applicable interest 
rate, mortality table, and salary scale used in the example to calculate 
the early retirement reductions.
    (ii) Conclusion. The information in the notice, as described in 
paragraphs (i)(C) and (D) of Example 4 and paragraph (i) of this Example 
5, satisfies the requirements of paragraph (a)(3) of this Q&A-11 with 
respect to applicable individuals who are participants. The requirements 
of paragraph (a)(4) of this Q&A-11 are satisfied because, as noted in 
paragraph (i) of this Example 5, the notice describes the early 
retirement subsidy under the old formula and describes the estimated 
early retirement pension under the new formula in terms that can be 
readily compared to the old formula, i.e., the notice states that the 
monthly early retirement pension of $270 is 38 percent less than the 
monthly normal retirement benefit of $434, whereas a 15 percent 
reduction would have applied under the plan as in effect before the 
amendment. The requirements of paragraph (a)(4)(ii) of this Q&A-11 that 
the examples include sufficient information to be able to determine the 
approximate magnitude of the reduction would also be satisfied if the 
notice instead directly stated the amount of the monthly early 
retirement pension that would be payable at age 59 under the old 
formula.

    Q-12. What special rules apply if participants can choose between 
the old and new benefit formulas?
    A-12. In any case in which an applicable individual can choose 
between the benefit formula (including any early retirement benefit or 
retirement-type subsidy) in effect before the section 204(h) amendment 
(old formula) or the benefit formula in effect after the section 204(h) 
amendment (new formula), section 204(h) notice has not been provided 
unless the applicable individual has been provided the information 
required under Q&A-11 of this section, and has also been provided 
sufficient information to enable the individual to make an informed 
choice between the

[[Page 358]]

old and new benefit formulas. The information required under Q&A-11 of 
this section must be provided by the date otherwise required under Q&A-9 
of this section. The information sufficient to enable the individual to 
make an informed choice must be provided within a period that is 
reasonably contemporaneous with the date by which the individual is 
required to make his or her choice and that allows sufficient advance 
notice to enable the individual to understand and consider the 
additional information before making that choice.
    Q-13. How may section 204(h) notice be provided?
    A-13. (a) Delivering section 204(h) notice. A plan administrator 
(including a person acting on behalf of the plan administrator, such as 
the employer or plan trustee) must provide section 204(h) notice through 
a method that results in actual receipt of the notice or the plan 
administrator must take appropriate and necessary measures reasonably 
calculated to ensure that the method for providing section 204(h) notice 
results in actual receipt of the notice. Section 204(h) notice must be 
provided either in the form of a paper document or in an electronic form 
that satisfies the requirements of paragraph (c) of this Q&A-13. First 
class mail to the last known address of the party is an acceptable 
delivery method. Likewise, hand delivery is acceptable. However, the 
posting of notice is not considered provision of section 204(h) notice. 
Section 204(h) notice may be enclosed with or combined with other notice 
provided by the employer or plan administrator (for example, a notice of 
intent to terminate under title IV of ERISA). Except as provided in 
paragraph (c) of this Q&A-13, a section 204(h) notice is deemed to have 
been provided on a date if it has been provided by the end of that day. 
When notice is delivered by first class mail, the notice is considered 
provided as of the date of the United States postmark stamped on the 
cover in which the document is mailed.
    (b) Example. The following example illustrates the provisions of 
paragraph (a) of this Q&A-13:

    Example. (i) Facts. Plan A is amended to reduce significantly the 
rate of future benefit accrual effective January 1, 2005. Under Q&A-9 of 
this section, section 204(h) notice is required to be provided at least 
45 days before the effective date of the amendment. The plan 
administrator causes section 204(h) notice to be mailed to all affected 
participants. The mailing is postmarked November 16, 2004.
    (ii) Conclusion. Because section 204(h) notice is given 45 days 
before the effective date of the plan amendment, it satisfies the timing 
requirement of Q&A-9 of this section.

    (c) New technologies--(1) General rule. A section 204(h) notice may 
be provided to an applicable individual through an electronic method 
(other than an oral communication or a recording of an oral 
communication), provided that all of the following requirements are 
satisfied:
    (i) Either the notice is actually received by the applicable 
individual or the plan administrator takes appropriate and necessary 
measures reasonably calculated to ensure that the method for providing 
section 204(h) notice results in actual receipt of the notice by the 
applicable individual.
    (ii) The section 204(h) notice is delivered using an electronic 
medium (other than an oral communication or a recording of an oral 
communication) under an electronic system that satisfies the applicable 
notice requirements of Sec. 1.401(a)-21.
    (iii) Special effective date. For plan years beginning prior to 
January 1, 2007, Q&A-13 of this section, as it appeared in the April 1, 
2006 edition of 26 CFR part 1, applies.
    (2) Examples. The following examples illustrate the requirement in 
paragraph (c)(1)(i) of this Q&A-13. In these examples, it is assumed 
that the notice satisfies the requirements in paragraphs (c)(1)(ii) of 
this section. The examples are as follows:

    Example 1. (i) Facts. On July 1, 2003, M, a plan administrator of 
Company N's plan, sends notice intended to constitute section 204(h) 
notice to A, an employee of Company N and a participant in the plan. The 
notice is sent through e-mail to A's e-mail address on Company N's 
electronic information system. Accessing Company N's electronic 
information system is not an integral part of A's duties. M sends the e-
mail with a request for a computer-generated notification that the 
message was received and opened. M receives notification indicating that 
the e-mail was received and opened by A on July 9, 2003.

[[Page 359]]

    (ii) Conclusion. With respect to A, although M has failed to take 
appropriate and necessary measures reasonably calculated to ensure that 
the method for providing section 204(h) notice results in actual receipt 
of the notice, M satisfies the requirement of paragraph (c)(1)(i) of 
this Q&A-13 on July 9, 2003, which is when A actually receives the 
notice.
    Example 2. (i) Facts. On August 1, 2003, O, a plan administrator of 
Company P's plan, sends a notice intended to constitute section 204(h) 
notice of ERISA to B, who is an employee of Company P and a participant 
in Company P's plan. The notice is sent through e-mail to B's e-mail 
address on Company P's electronic information system. B has the ability 
to effectively access electronic documents from B's e-mail address on 
Company P's electronic information system and accessing the system is an 
integral part of B's duties.
    (ii) Conclusion. Because access to the system is an integral part of 
B's duties, O has taken appropriate and necessary measures reasonably 
calculated to ensure that the method for providing section 204(h) notice 
results in actual receipt of the notice. Thus, regardless of whether B 
actually accesses B's email on that date, O satisfies the requirement of 
paragraph (c)(1)(i) of this Q&A-13 on August 1, 2003, with respect to B.

    Q-14. What are the consequences if a plan administrator fails to 
provide section 204(h) notice?
    A-14. (a) Egregious failures--(1) Effect of egregious failure to 
provide section 204(h) notice. Section 204(h)(6)(A) of ERISA provides 
that, in the case of any egregious failure to meet the notice 
requirements with respect to any plan amendment, the plan provisions are 
applied so that all applicable individuals are entitled to the greater 
of the benefit to which they would have been entitled without regard to 
the amendment, or the benefit under the plan with regard to the 
amendment. For a special rule applicable in the case of a plan 
termination, see Q&A-17(b) of this section.
    (2) Definition of egregious failure. For purposes of section 204(h) 
of ERISA and this Q&A-14, there is an egregious failure to meet the 
notice requirements if a failure to provide required notice is within 
the control of the plan sponsor and is either an intentional failure or 
a failure, whether or not intentional, to provide most of the 
individuals with most of the information they are entitled to receive. 
For this purpose, an intentional failure includes any failure to 
promptly provide the required notice or information after the plan 
administrator discovers an unintentional failure to meet the 
requirements. A failure to give section 204(h) notice is deemed not to 
be egregious if the plan administrator reasonably determines, taking 
into account section 4980F, section 204(h), these regulations, other 
administrative pronouncements, and relevant facts and circumstances, 
that the reduction in the rate of future benefit accrual resulting from 
an amendment is not significant (as described in Q&A-8 of this section), 
or that an amendment does not significantly reduce an early retirement 
benefit or retirement-type subsidy.
    (3) Example. The following example illustrates the provisions of 
this paragraph (a):

    Example. (i) Facts. Plan A is amended to reduce significantly the 
rate of future benefit accrual effective January 1, 2003. Section 204(h) 
notice is required to be provided 45 days before January 1, 2003. Timely 
section 204(h) notice is provided to all applicable individuals (and to 
each employee organization representing participants who are applicable 
individuals), except that the employer intentionally fails to provide 
section 204(h) notice to certain participants until May 16, 2003.
    (ii) Conclusion. The failure to provide section 204(h) notice is 
egregious. Accordingly, for the period from January 1, 2003 through June 
30, 2003 (which is the date that is 45 days after May 16, 2003), all 
participants and alternate payees are entitled to the greater of the 
benefit to which they would have been entitled under Plan A as in effect 
before the amendment or the benefit under the plan as amended.

    (b) Effect of non-egregious failure to provide section 204(h) 
notice. If an egregious failure has not occurred, the amendment with 
respect to which section 204(h) notice is required may become effective 
with respect to all applicable individuals. However, see section 502 of 
ERISA for civil enforcement remedies. Thus, where there is a failure, 
whether or not egregious, to provide section 204(h) notice in accordance 
with this section, individuals may have recourse under section 502 of 
ERISA.
    (c) Excise taxes. See section 4980F and Q&A-15 of this section for 
excise taxes that may apply to a failure to notify applicable 
individuals of a pension plan amendment that provides for a significant 
reduction in the rate of future

[[Page 360]]

benefit accrual or eliminates or significantly reduces an early 
retirement benefit or retirement-type subsidy, regardless of whether or 
not the failure is egregious.
    Q-15. What are some of the rules that apply with respect to the 
excise tax under section 4980F?
    A-15. (a) Person responsible for excise tax. In the case of a plan 
other than a multiemployer plan, the employer is responsible for 
reporting and paying the excise tax. In the case of a multiemployer 
plan, the plan is responsible for reporting and paying the excise tax.
    (b) Excise tax inapplicable in certain cases. Under section 
4980F(c)(1) of the Internal Revenue Code, no excise tax is imposed on a 
failure for any period during which it is established to the 
satisfaction of the Commissioner that the employer (or other person 
responsible for the tax) exercised reasonable diligence, but did not 
know that the failure existed. Under section 4980F(c)(2) of the Internal 
Revenue Code, no excise tax applies to a failure to provide section 
204(h) notice if the employer (or other person responsible for the tax) 
exercised reasonable diligence and corrects the failure within 30 days 
after the employer (or other person responsible for the tax) first knew, 
or exercising reasonable diligence would have known, that such failure 
existed. For purposes of section 4980F(c)(1) of the Internal Revenue 
Code, a person has exercised reasonable diligence, but did not know that 
the failure existed if and only if--
    (1) The person exercised reasonable diligence in attempting to 
deliver section 204(h) notice to applicable individuals by the latest 
date permitted under this section; and
    (2) At the latest date permitted for delivery of section 204(h) 
notice, the person reasonably believes that section 204(h) notice was 
actually delivered to each applicable individual by that date.
    (c) Example. The following example illustrates the provisions of 
paragraph (b) of this Q&A-15:

    Example. (i) Facts. Plan A is amended to reduce significantly the 
rate of future benefit accrual. The employer sends out a section 204(h) 
notice to all affected participants and other applicable individuals and 
to any employee organization representing applicable individuals, 
including actual delivery by hand to employees at worksites and by 
first-class mail for any other applicable individual and to any employee 
organization representing applicable individuals. However, although the 
employer exercises reasonable diligence in seeking to deliver the 
notice, the notice is not delivered to any participants at one worksite 
due to a failure of an overnight delivery service to provide the notice 
to appropriate personnel at that site for them to timely hand deliver 
the notice to affected employees. The error is discovered when the 
employer subsequently calls to confirm delivery. Appropriate section 
204(h) notice is then promptly delivered to all affected participants at 
the worksite.
    (ii) Conclusion. Because the employer exercised reasonable 
diligence, but did not know that a failure existed, no excise tax 
applies, assuming that participants at the worksite receive section 
204(h) notice within 30 days after the employer first knew, or 
exercising reasonable diligence would have known, that the failure 
occurred.

    Q-16. How do section 4980F and section 204(h) apply when a business 
is sold?
    A-16. (a) Generally. Whether section 204(h) notice is required in 
connection with the sale of a business depends on whether a plan 
amendment is adopted that significantly reduces the rate of future 
benefit accrual or significantly reduces an early retirement benefit or 
retirement-type subsidy.
    (b) Examples. The following examples illustrate the rules of this 
Q&A-16:

    Example 1. (i) Facts. Corporation Q maintains Plan A, a defined 
benefit plan that covers all employees of Corporation Q, including 
employees in its Division M. Plan A provides that participating 
employees cease to accrue benefits when they cease to be employees of 
Corporation Q. On January 1, 2006, Corporation Q sells all of the assets 
of Division M to Corporation R. Corporation R maintains Plan B, which 
covers all of the employees of Corporation R. Under the sale agreement, 
employees of Division M become employees of Corporation R on the date of 
the sale (and cease to be employees of Corporation Q), Corporation Q 
continues to maintain Plan A following the sale, and the employees of 
Division M become participants in Plan B.
    (ii) Conclusion. No section 204(h) notice is required because no 
plan amendment was adopted that reduced the rate of future benefit 
accrual. The employees of Division M who become employees of Corporation 
R ceased to accrue benefits under Plan A because their employment with 
Corporation Q terminated.

[[Page 361]]

    Example 2. (i) Facts. Subsidiary Y is a wholly owned subsidiary of 
Corporation S. Subsidiary Y maintains Plan C, a defined benefit plan 
that covers employees of Subsidiary Y. Corporation S sells all of the 
stock of Subsidiary Y to Corporation T. At the effective date of the 
sale of the stock of Subsidiary Y, in accordance with the sale agreement 
between Corporation S and Corporation T, Subsidiary Y amends Plan C so 
that all benefit accruals cease.
    (ii) Conclusion. Section 204(h) notice is required to be provided 
because Subsidiary Y adopted a plan amendment that significantly reduced 
the rate of future benefit accrual in Plan C.
    Example 3. (i) Facts. As a result of an acquisition, Corporation U 
maintains two defined benefit plans: Plan D covers employees of Division 
N and Plan E covers the rest of the employees of Corporation U. Plan E 
provides a significantly lower rate of future benefit accrual than Plan 
D. Plan D is merged with Plan E, and all of the employees of Corporation 
U will accrue benefits under the merged plan in accordance with the 
benefit formula of former Plan E.
    (ii) Conclusion. Section 204(h) notice is required.
    Example 4. (i) Facts. The facts are the same as in Example 3, except 
that the rate of future benefit accrual in Plan E is not significantly 
lower. In addition, Plan D has a retirement-type subsidy that Plan E 
does not have and the Plan D employees' rights to the subsidy under the 
merged plan are limited to benefits accrued before the merger.
    (ii) Conclusion. Section 204(h) notice is required for any 
participants or beneficiaries for whom the reduction in the retirement-
type subsidy is significant (and for any employee organization 
representing such participants).
    Example 5. (i) Facts. Corporation V maintains several plans, 
including Plan F, which covers employees of Division P. Plan F provides 
that participating employees cease to accrue further benefits under the 
plan when they cease to be employees of Corporation V. Corporation V 
sells all of the assets of Division P to Corporation W, which maintains 
Plan G for its employees. Plan G provides a significantly lower rate of 
future benefit accrual than Plan F. Plan F is merged with Plan G as part 
of the sale, and employees of Division P who become employees of 
Corporation W will accrue benefits under the merged plan in accordance 
with the benefit formula of former Plan G.
    (ii) Conclusion. No section 204(h) notice is required because no 
plan amendment was adopted that reduces the rate of future benefit 
accrual or eliminates or significantly reduces an early retirement 
benefit or retirement-type subsidy. Under the terms of Plan F as in 
effect prior to the merger, employees of Division P cease to accrue any 
further benefits (including benefits with respect to early retirement 
benefits and any retirement-type subsidy) under Plan F after the date of 
the sale because their employment with Corporation V terminated.

    Q-17. How are amendments to cease accruals and terminate a plan 
treated under section 4980F and section 204(h)?
    A-17. (a) General rule--(1) Rule. An amendment providing for the 
cessation of benefit accruals on a specified future date and for the 
termination of a plan is subject to section 4980F and section 204(h).
    (2) Example. The following example illustrates the rule of paragraph 
(a)(1) of this Q&A-17:

    Example. (i) Facts. An employer adopts an amendment that provides 
for the cessation of benefit accruals under a defined benefit plan on 
December 31, 2003, and for the termination of the plan pursuant to title 
IV of ERISA as of a proposed termination date that is also December 31, 
2003. As part of the notice of intent to terminate required under title 
IV in order to terminate the plan, the plan administrator gives section 
204(h) notice of the amendment ceasing accruals, which states that 
benefit accruals will cease ``on December 31, 2003 whether or not the 
plan is terminated on that date.'' However, because all the requirements 
of title IV for a plan termination are not satisfied, the plan cannot be 
terminated until a date that is later than December 31, 2003.
    (ii) Conclusion. Nonetheless, because section 204(h) notice was 
given stating that the plan was amended to cease accruals on December 
31, 2003, section 204(h) does not prevent the amendment to cease 
accruals from being effective on December 31, 2003. The result would be 
the same had the section 204(h) notice informed the participants that 
the plan was amended to provide for a proposed termination date of 
December 31, 2003 and to provide that ``benefit accruals will cease on 
the proposed termination date whether or not the plan is terminated on 
that date.'' However, neither section 4980F nor section 204(h) would be 
satisfied with respect to the December 31, 2003 effective date if the 
section 204(h) notice had merely stated that benefit accruals would 
cease ``on the termination date'' or ``on the proposed termination 
date.''

    (3) Additional requirements under title IV of ERISA. See 29 CFR 
4041.23(b)(4) and 4041.43(b)(5) for special rules applicable to plans 
terminating under title IV of ERISA.
    (b) Terminations in accordance with title IV of ERISA. A plan that 
is terminated in accordance with title IV of

[[Page 362]]

ERISA is deemed to have satisfied section 4980F and section 204(h) not 
later than the termination date (or date of termination, as applicable) 
established under section 4048 of ERISA. Accordingly, neither section 
4980F nor section 204(h) would in any event require that any additional 
benefits accrue after the effective date of the termination.
    (c) Amendment effective before termination date of a plan subject to 
title IV of ERISA. To the extent that an amendment providing for a 
significant reduction in the rate of future benefit accrual or a 
significant reduction in an early retirement benefit or retirement-type 
subsidy has an effective date that is earlier than the termination date 
(or date of termination, as applicable) established under section 4048 
of ERISA, that amendment is subject to section 4980F and section 204(h). 
Accordingly, the plan administrator must provide section 204(h) notice 
(either separately, with, or as part of the notice of intent to 
terminate) with respect to such an amendment.
    Q-18. What are the effective dates of section 4980F, section 204(h), 
as amended by EGTRRA, and these regulations?
    A-18. (a) Statutory effective date--(1) General rule. Section 4980F 
and section 204(h), as amended by EGTRRA, apply to plan amendments 
taking effect on or after June 7, 2001 (statutory effective date), which 
is the date of enactment of EGTRRA.
    (2) Transition rule. For amendments applying after the statutory 
effective date in paragraph (a)(1) of this Q&A-18 and prior to the 
regulatory effective date in paragraph (c) of this Q&A-18, the 
requirements of section 4980F(e)(2) and (3) of the Internal Revenue Code 
and section 204(h), as amended by EGTRRA, are treated as satisfied if 
the plan administrator makes a reasonable, good faith effort to comply 
with those requirements.
    (3) Special notice rule--(i) In general. Notwithstanding Q&A-9 of 
this section, section 204(h) notice is not required by section 4980F(e) 
of the Internal Revenue Code or section 204(h), as amended by EGTRRA, to 
be provided prior to September 7, 2001 (the date that is three months 
after the date of enactment of EGTRRA).
    (ii) Reasonable notice. The requirements of section 4980F and 
section 204(h), as amended by EGTRRA, do not apply to any plan amendment 
that takes effect on or after June 7, 2001 if, before April 25, 2001, 
notice was provided to participants and beneficiaries adversely affected 
by the plan amendment (and their representatives) which was reasonably 
expected to notify them of the nature and effective date of the plan 
amendment. For purposes of this paragraph (a)(3)(ii), notice that 
complies with Sec. 1.411(d)-6 of this chapter, as it appeared in the 
April 1, 2001 edition of 26 CFR part 1, is deemed to be notice which was 
reasonably expected to notify participants and beneficiaries adversely 
affected by the plan amendment (and their representatives) of the nature 
and effective date of the plan amendment.
    (4) Special effective date for certain section 204(h) amendments 
made by plans of commercial airlines. Section 402 of PPA `06 applies to 
section 204(h) amendments adopted in plan years ending after August 17, 
2006.
    (5) Special effective date for rule relating to contributing 
employers. Section 502(c) of PPA '06, which amended section 4980F(e)(1) 
of the Internal Revenue Code, applies to section 204(h) amendments 
adopted in plan years beginning after December 31, 2007.
    (b) Regulatory effective date--(1) General effective date. Except as 
otherwise provided in this paragraph (b) of this section, Q&A-1 through 
Q&A-18 of this section apply to amendments with an effective date that 
is on or after September 1, 2003.
    (2) Effective date for Q&A-7(a)(2). Q&A-7(a)(2) of this section 
applies to amendments with an effective date that is on or after January 
1, 2004.
    (3) Effective dates for Q&A-9(g)(1), (g)(3), and (g)(4)--(i) General 
effective date. Except as otherwise provided in Q&A-18(b)(3)(ii) or 
(b)(3)(iii) of this section, Q&A-9(g)(1), (g)(3), and (g)(4) of this 
section apply to amendments that are effective on or after January 1, 
2008.
    (ii) Effective dates for Q&A-9(g)(2) and Q&A-7(b). Except as 
otherwise provided in Q&A-18(b)(3)(iii) of this section,

[[Page 363]]

Q&A-9(g)(2) and Q&A-7(b) of this section apply to section 204(h) 
amendments adopted in plan years beginning after July 1, 2008.
    (iii) Special rules for section 204(h) amendments to an applicable 
defined benefit plan. Except as otherwise provided in paragraph 
(b)(3)(i) or (b)(3)(ii) of this Q&A-18, with respect to any section 
204(h) notice provided in connection with a section 204(h) amendment to 
an applicable defined benefit plan within the meaning of section 
411(a)(13)(C)(i) to limit distributions as permitted under section 
411(a)(13)(A) for distributions made after August 17, 2006, that is made 
pursuant to section 701 of PPA '06, paragraphs (g)(1) and (g)(2) of Q&A-
9 of this section apply to amendments that are effective after December 
21, 2006. For such an amendment that is effective not later than 
December 31, 2008, section 204(h) notice does not fail to be timely if 
the notice is provided at least 30 days, rather than 45 days, before the 
date that the amendment is first effective.
    (c) Amendments taking effect prior to June 7, 2001. For rules 
applicable to amendments taking effect prior to June 7, 2001, see Sec. 
1.411(d)-6 of this chapter, as it appeared in the April 1, 2001 edition 
of 26 CFR part 1.

[T.D. 9052, 68 FR 17281, Apr. 9, 2003, as amended by T.D. 9219, 70 FR 
47126, Aug. 12, 2005; T.D. 9294, 71 FR 61888, Oct. 20, 2006; T.D. 9472, 
74 FR 61276, Nov. 24, 2009]



Sec. 54.4980G-0  Table of contents.

    This section contains the questions for Sec. Sec. 54.4980G-1, 
54.4980G-2, 54.4980G-3, 54.4980G-4, and 54.4980G-5.

 Sec. 54.4980G-1 Failure of employer to make comparable health savings 
                         account contributions.

    Q-1: What are the comparability rules that apply to employer 
contributions to Health Savings Accounts (HSAs)?
    Q-2: What are the categories of HDHP coverage for purposes of 
applying the comparability rules?
    Q-3: What is the testing period for making comparable contributions 
to employees' HSAs?
    Q-4: How is the excise tax computed if employer contributions do not 
satisfy the comparability rules for a calendar year?

             Sec. 54.4980G-2 Employer contribution defined.

    Q-1: Do the comparability rules apply to amounts rolled over from an 
employee's HSA or Archer Medical Savings Account (Archer MSA)?
    Q-2: If an employee requests that his or her employer deduct after-
tax amounts from the employee's compensation and forward these amounts 
as employee contributions to the employee's HSA, do the comparability 
rules apply to these amounts?

          Sec. 54.4980G-3 Employee for comparability testing.

    Q-1: Do the comparability rules apply to contributions that an 
employer makes to the HSAs of independent contractors or self-employed 
individuals?
    Q-2: May a sole proprietor who is an eligible individual contribute 
to his or her own HSA without contributing to the HSAs of his or her 
employees who are eligible individuals?
    Q-3: Do the comparability rules apply to contributions by a 
partnership to a partner's HSA?
    Q-4: How are members of controlled groups treated when applying the 
comparability rules?
    Q-5: What are the categories of employees for comparability testing?
    Q-6: Are employees who are included in a unit of employees covered 
by a collective bargaining agreement comparable participating employees?
    Q-7: Is an employer permitted to make comparable contributions only 
to the HSAs of comparable participating employees who have coverage 
under the employer's HDHP?
    Q-8: If an employee and his or her spouse are eligible individuals 
who work for the same employer and one employee-spouse has family 
coverage for both employees under the employer's HDHP, must the employer 
make comparable contributions to the HSAs of both employees?
    Q-9: Does an employer that makes HSA contributions only for one 
class of non-collectively bargained employees who are eligible 
individuals, but not for another class of non-collectively bargained 
employees who are eligible individuals (for example, management v. non-
management) satisfy the requirement that the employer make comparable 
contributions?
    Q-10: If an employer contributes to the HSAs of former employees who 
are eligible individuals, do the comparability rules apply to these 
contributions?
    Q-11: Is an employer permitted to make comparable contributions only 
to the HSAs of comparable participating former employees who have 
coverage under the employer's HDHP?

[[Page 364]]

    Q-12: If an employer contributes only to the HSAs of former 
employees who are eligible individuals with coverage under the 
employer's HDHP, must the employer make comparable contributions to the 
HSAs of former employees who are eligible individuals with coverage 
under the employer's HDHP because of an election under a COBRA 
continuation provision (as defined in section 9832(d)(1))?
    Q-13: How do the comparability rules apply if some employees have 
HSAs and other employees have Archer MSAs?

         Sec. 54.4980G-4 Calculating comparable contributions.

    Q-1: What are comparable contributions?
    Q-2: How does an employer comply with the comparability rules when 
some non-collectively bargained employees who are eligible individuals 
do not work for the employer during the entire calendar year?
    Q-3: How do the comparability rules apply to employer contributions 
to employees' HSAs if some non-collectively bargained employees work 
full-time during the entire calendar year, and other non-collectively 
bargained employees work full-time for less than the entire calendar 
year?
    Q-4: May an employer make contributions for the entire year to the 
HSAs of its employees who are eligible individuals at the beginning of 
the calendar year (i.e., on a pre-funded basis) instead of contributing 
on a pay-as-you-go or on a look-back basis?
    Q-5: Must an employer use the same contribution method as described 
in Q & A-2 and Q & A-4 of this section for all employees for any month 
during the calendar year?
    Q-6: How does an employer comply with the comparability rules if an 
employee has not established an HSA at the time the employer contributes 
to its employees' HSAs?
    Q-7: If an employer bases its contributions on a percentage of the 
HDHP deductible, how is the correct percentage or dollar amount 
computed?
    Q-8: Does an employer that contributes to the HSA of each comparable 
participating employee in an amount equal to the employee's HSA 
contribution or a percentage of the employee's HSA contribution 
(matching contributions) satisfy the rule that all comparable 
participating employees receive comparable contributions?
    Q-9: If an employer conditions contributions by the employer to an 
employee's HSA on an employee's participation in health assessments, 
disease management programs or wellness programs and makes the same 
contributions available to all employees who participate in the 
programs, do the contributions satisfy the comparability rules?
    Q-10: If an employer makes additional contributions to the HSAs of 
all comparable participating employees who have attained a specified age 
or who have worked for the employer for a specified number of years, do 
the contributions satisfy the comparability rules?
    Q-11: If an employer makes additional contributions to the HSAs of 
all comparable participating employees who are eligible to make the 
additional contributions (HSA catch-up contributions) under section 
223(b)(3), do the contributions satisfy the comparability rules?
    Q-12: If an employer's contributions to an employee's HSA result in 
non-comparable contributions, may the employer recoup the excess amount 
from the employee's HSA?
    Q-13: What constitutes a reasonable interest rate for purposes of 
making comparable contributions?
    Q-14: How does an employer comply with the comparability rules if an 
employee has not established an HSA by December 31st?
    Q-15: For any calendar year, may an employer accelerate part or all 
of its contributions for the entire year to the HSAs of employees who 
have incurred, during the calendar year, qualified medical expenses (as 
defined in section 223(d)(2)) exceeding the employer's cumulative HSA 
contributions at that time?
    Q-16: What is the effective date for the rules in Q & A-14 and Q & 
A-15 of this section?

Sec. 54.4980G-5 HSA comparability rules and cafeteria plans and waiver 
                             of excise tax.

    Q-1: If an employer makes contributions through a section 125 
cafeteria plan to the HSA of each employee who is an eligible 
individual, are the contributions subject to the comparability rules?
    Q-2: If an employer makes contributions through a cafeteria plan to 
the HSA of each employee who is an eligible individual in an amount 
equal to the amount of the employee's HSA contribution or a percentage 
of the amount of the employee's HSA contribution (i.e., matching 
contributions), are the contributions subject to the section 4980G 
comparability rules?
    Q-3: If under the employer's cafeteria plan, employees who are 
eligible individuals and who participate in health assessments, disease 
management programs or wellness programs receive an employer 
contribution to an HSA and the employees have the right to elect to make 
pre-tax salary reduction contributions to their HSAs, are the 
contributions subject to the comparability rules?
    Q-4: May all or part of the excise tax imposed under section 4980G 
be waived?

[T.D. 9277, 71 FR 43058, July 31, 2006; 71 FR 53967, Sept. 13, 2006, as 
amended by T.D. 9393, 73 FR 20795, Apr. 17, 2008]

[[Page 365]]



Sec. 54.4980G-1  Failure of employer to make comparable health savings
account contributions.

    Q-1: What are the comparability rules that apply to employer 
contributions to Health Savings Accounts (HSAs)?
    A-1: If an employer makes contributions to any employee's HSA, the 
employer must make comparable contributions to the HSAs of all 
comparable participating employees. See Q & A-1 in Sec. 54.4980G-4 for 
the definition of comparable contributions. Comparable participating 
employees are eligible individuals (as defined in section 223(c)(1)) who 
are in the same category of employees and who have the same category of 
high deductible health plan (HDHP) coverage. See sections 4980G(b) and 
4980E(d)(3). See section 223(c)(2) and (g) for the definition of an 
HDHP. See also Q & A-5 in Sec. 54.4980G-3 for the categories of 
employees and Q & A-2 of this section for the categories of HDHP 
coverage. But see Q & A-6 in Sec. 54.4980G-3 for treatment of 
collectively bargained employees and Q & A-1 in Sec. 54.4980G-6 for the 
rules allowing larger comparable contributions to nonhighly compensated 
employees.
    Q-2: What are the categories of HDHP coverage for purposes of 
applying the comparability rules?
    A-2: (a) In general. Generally, the categories of coverage are self-
only HDHP coverage and family HDHP coverage. Family HDHP coverage means 
any coverage other than self-only HDHP coverage. The comparability rules 
apply separately to self-only HDHP coverage and family HDHP coverage. In 
addition, if an HDHP has family coverage options meeting the 
descriptions listed in paragraph (b) of this Q & A-2, each such coverage 
option may be treated as a separate category of coverage and the 
comparability rules may be applied separately to each category. However, 
if the HDHP has more than one category that provides coverage for the 
same number of individuals, all such categories are treated as a single 
category for purposes of the comparability rules. Thus, the categories 
of ``employee plus spouse'' and ``employee plus dependent,'' each 
providing coverage for two individuals, are treated as the single 
category ``self plus one'' for comparability purposes. See, however, the 
final sentence of paragraph (a) of Q & A-1 of Sec. 54.4980G-4 for a 
special rule that applies if different amounts are contributed for 
different categories of family coverage. See also Sec. 54.4980G-6 for 
the rules allowing larger comparable contributions to nonhighly 
compensated employees.
    (b) HDHP Family coverage categories. The coverage categories are--
    (1) Self plus one;
    (2) Self plus two; and
    (3) Self plus three or more.
    (c) Examples. The rules of this Q & A-2 are illustrated by the 
following examples:

    Example 1. Employer A maintains an HDHP and contributes to the HSAs 
of eligible employees who elect coverage under the HDHP. The HDHP has 
self-only coverage and family coverage. Thus, the categories of coverage 
are self-only and family coverage. Employer A contributes $750 to the 
HSA of each eligible employee with self-only HDHP coverage and $1,000 to 
the HSA of each eligible employee with family HDHP coverage. Employer 
A's contributions satisfy the comparability rules.
    Example 2. (i) Employer B maintains an HDHP and contributes to the 
HSAs of eligible employees who elect coverage under the HDHP. The HDHP 
has the following coverage options:
    (A) Self-only;
    (B) Self plus spouse;
    (C) Self plus dependent;
    (D) Self plus spouse plus one dependent;
    (E) Self plus two dependents; and
    (F) Self plus spouse and two or more dependents.
    (ii) The self plus spouse category and the self plus dependent 
category constitute the same category of HDHP coverage (self plus one) 
and Employer B must make the same comparable contributions to the HSAs 
of all eligible individuals who are in either the self plus spouse 
category of HDHP coverage or the self plus dependent category of HDHP 
coverage. Likewise, the self plus spouse plus one dependent category and 
the self plus two dependents category constitute the same category of 
HDHP coverage (self plus two) and Employer B must make the same 
comparable contributions to the HSAs of all eligible individuals who are 
in either the self plus spouse plus one dependent category of HDHP 
coverage or the self plus two dependents category of HDHP coverage.
    Example 3. (i) Employer C maintains an HDHP and contributes to the 
HSAs of eligible employees who elect coverage under the HDHP. The HDHP 
has the following coverage options:

[[Page 366]]

    (A) Self-only;
    (B) Self plus one;
    (C) Self plus two; and
    (D) Self plus three or more.
    (ii) Employer C contributes $500 to the HSA of each eligible 
employee with self-only HDHP coverage, $750 to the HSA of each eligible 
employee with self plus one HDHP coverage, $900 to the HSA of each 
eligible employee with self plus two HDHP coverage and $1,000 to the HSA 
of each eligible employee with self plus three or more HDHP coverage. 
Employer C's contributions satisfy the comparability rules.

    Q-3: What is the testing period for making comparable contributions 
to employees' HSAs?
    A-3: To satisfy the comparability rules, an employer must make 
comparable contributions for the calendar year to the HSAs of employees 
who are comparable participating employees. See section 4980G(a). See Q 
& A-3 and Q & A-4 in Sec. 54.4980G-4 for a discussion of HSA 
contribution methods.
    Q-4: How is the excise tax computed if employer contributions do not 
satisfy the comparability rules for a calendar year?
    A-4: (a) Computation of tax. If employer contributions do not 
satisfy the comparability rules for a calendar year, the employer is 
subject to an excise tax equal to 35% of the aggregate amount 
contributed by the employer to HSAs for that period.
    (b) Example. The following example illustrates the rules in 
paragraph (a) of this Q & A-4:

    Example. During the 2007 calendar year, Employer D has 8 employees 
who are eligible individuals with self-only coverage under an HDHP 
provided by Employer D. The deductible for the HDHP is $2,000. For the 
2007 calendar year, Employer D contributes $2,000 each to the HSAs of 
two employees and $1,000 each to the HSAs of the other six employees, 
for total HSA contributions of $10,000. Employer D's contributions do 
not satisfy the comparability rules. Therefore, Employer D is subject to 
an excise tax of $3,500 (35% of $10,000) for its failure to make 
comparable contributions to its employees' HSAs.
    Q-5: If a person is liable for the excise tax under section 4980G, 
what form must the person file and what is the due date for the filing 
and payment of the excise tax?
    A-5: (a) In general. Sec. Sec. 54.6011-2, 54.6151-1 and 54.6071-
1(d).
    (b) Effective/applicability date. The rules in this Q & A-5 are 
effective for employer contributions made for calendar years beginning 
on or after January 1, 2010.

[T.D. 9277, 71 FR 43058, July 31, 2006, as amended by T.D. 9457, 74 FR 
45997, Sept. 8, 2009]



Sec. 54.4980G-2  Employer contribution defined.

    Q-1: Do the comparability rules apply to amounts rolled over from an 
employee's HSA or Archer Medical Savings Account (Archer MSA)?
    A-1: No. The comparability rules do not apply to amounts rolled over 
from an employee's HSA or Archer MSA.
    Q-2: If an employee requests that his or her employer deduct after-
tax amounts from the employee's compensation and forward these amounts 
as employee contributions to the employee's HSA, do the comparability 
rules apply to these amounts?
    A-2: No. Section 106(d) provides that amounts contributed by an 
employer to an eligible employee's HSA shall be treated as employer-
provided coverage for medical expenses and are excludible from the 
employee's gross income up to the limit in section 223(b). After-tax 
employee contributions to an HSA are not subject to the comparability 
rules because they are not employer contributions under section 106(d).

[T.D. 9277, 71 FR 43058, July 31, 2006]



Sec. 54.4980G-3  Failure of employer to make comparable health savings
account contributions.

    Q-1: Do the comparability rules apply to contributions that an 
employer makes to the HSAs of independent contractors or self-employed 
individuals?
    A-1: No. The comparability rules apply only to contributions that an 
employer makes to the HSAs of employees.
    Q-2: May a sole proprietor who is an eligible individual contribute 
to his or her own HSA without contributing to the HSAs of his or her 
employees who are eligible individuals?
    A-2: (a) Sole proprietor not an employee. Yes. The comparability 
rules apply only to contributions made by an employer to the HSAs of 
employees.

[[Page 367]]

Because a sole proprietor is not an employee, the comparability rules do 
not apply to contributions the sole proprietor makes to his or her own 
HSA. However, if a sole proprietor contributes to any employee's HSA, 
the sole proprietor must make comparable contributions to the HSAs of 
all comparable participating employees. In determining whether the 
comparability rules are satisfied, contributions that a sole proprietor 
makes to his or her own HSA are not taken into account.
    (b) Example. The following example illustrates the rules in 
paragraph (a) of this Q & A-2:

    Example. In a calendar year, B, a sole proprietor is an eligible 
individual and contributes $1,000 to B's own HSA. B also contributes 
$500 for the same calendar year to the HSA of each employee who is an 
eligible individual. The comparability rules are not violated by B's 
$1,000 contribution to B's own HSA.

    Q-3: Do the comparability rules apply to contributions by a 
partnership to a partner's HSA?
    A-3: (a) Partner not an employee. No. Contributions by a partnership 
to a bona fide partner's HSA are not subject to the comparability rules 
because the contributions are not contributions by an employer to the 
HSA of an employee. The contributions are treated as either guaranteed 
payments under section 707(c) or distributions under section 731. 
However, if a partnership contributes to the HSAs of any employee who is 
not a partner, the partnership must make comparable contributions to the 
HSAs of all comparable participating employees.
    (b) Example. The following example illustrates the rules in 
paragraph (a) of this Q & A-3:

    Example. (i) Partnership X is a limited partnership with three equal 
individual partners, A (a general partner), B (a limited partner), and C 
(a limited partner). C is to be paid $300 annually for services rendered 
to Partnership X in her capacity as a partner without regard to 
partnership income (a section 707(c) guaranteed payment). D and E are 
the only employees of Partnership X and are not partners in Partnership 
X. A, B, C, D, and E are eligible individuals and each has an HSA. 
During Partnership X's Year 1 taxable year, which is also a calendar 
year, Partnership X makes the following contributions--
    (A) A $300 contribution to each of A's and B's HSAs which are 
treated as section 731 distributions to A and B;
    (B) A $300 contribution to C's HSA in lieu of paying C the 
guaranteed payment directly; and
    (C) A $200 contribution to each of D's and E's HSAs, who are 
comparable participating employees.
    (ii) Partnership X's contributions to A's and B's HSAs are section 
731 distributions, which are treated as cash distributions. Partnership 
X's contribution to C's HSA is treated as a guaranteed payment under 
section 707(c). The contribution is not excludible from C's gross income 
under section 106(d) because the contribution is treated as a 
distributive share of partnership income for purposes of all Code 
sections other than sections 61(a) and 162(a), and a guaranteed payment 
to a partner is not treated as compensation to an employee. Thus, 
Partnership X's contributions to the HSAs of A, B, and C are not subject 
to the comparability rules. Partnership X's contributions to D's and E's 
HSAs are subject to the comparability rules because D and E are 
employees of Partnership X and are not partners in Partnership X. 
Partnership X's contributions satisfy the comparability rules.

    Q-4: How are members of controlled groups treated when applying the 
comparability rules?
    A-4: All persons or entities treated as a single employer under 
section 414 (b), (c), (m), or (o) are treated as one employer. See 
sections 4980G(b) and 4980E(e).
    Q-5: What are the categories of employees for comparability testing?
    A-5: (a) Categories. The categories of employees for comparability 
testing are as follows (but see Q & A-6 of this section for the 
treatment of collectively bargained employees and Q & A-1 of Sec. 
54.4980G-6 for a special rule for contributions made to the HSAs of 
nonhighly compensated employees)--
    (1) Current full-time employees;
    (2) Current part-time employees; and
    (3) Former employees (except for former employees with coverage 
under the employer's HDHP because of an election under a COBRA 
continuation provision (as defined in section 9832(d)(1)).
    (b) Part-time and full-time employees. For purposes of section 
4980G, part-time employees are customarily employed for fewer than 30 
hours per week and full-time employees are customarily employed for 30 
or more hours per

[[Page 368]]

week. See sections 4980G(b) and 4980E(d)(4)(A) and (B).
    (c) In general. Except as provided in Q & A-6 of this section, the 
categories of employees in paragraph (a) of this Q & A-5 are the 
exclusive categories of employees for comparability testing. An employer 
must make comparable contributions to the HSAs of all comparable 
participating employees (eligible individuals who are in the same 
category of employees with the same category of HDHP coverage) during 
the calendar year without regard to any classification other than these 
categories. For example, full-time eligible employees with self-only 
HDHP coverage and part-time eligible employees with self-only HDHP 
coverage are separate categories of employees and different amounts can 
be contributed to the HSAs for each of these categories. But see Sec. 
54.4980G-6 for a special rule for contributions made to the HSAs of 
nonhighly compensated employees.
    Q-6: Are employees who are included in a unit of employees covered 
by a collective bargaining agreement comparable participating employees?
    A-6: (a) In general. No. Collectively bargained employees who are 
covered by a bona fide collective bargaining agreement between employee 
representatives and one or more employers are not comparable 
participating employees, if health benefits were the subject of good 
faith bargaining between such employee representatives and such employer 
or employers. Former employees covered by a collective bargaining 
agreement also are not comparable participating employees.
    (b) Examples. The following examples illustrate the rules in 
paragraph (a) of this Q & A-6. The examples read as follows:

    Example 1. Employer A offers its employees an HDHP with a $1,500 
deductible for self-only coverage. Employer A has collectively bargained 
and non-collectively bargained employees. The collectively bargained 
employees are covered by a collective bargaining agreement under which 
health benefits were bargained in good faith. In the 2007 calendar year, 
Employer A contributes $500 to the HSAs of all eligible non-collectively 
bargained employees with self-only coverage under Employer A's HDHP. 
Employer A does not contribute to the HSAs of the collectively bargained 
employees. Employer A's contributions to the HSAs of non-collectively 
bargained employees satisfy the comparability rules. The comparability 
rules do not apply to collectively bargained employees.
    Example 2. Employer B offers its employees an HDHP with a $1,500 
deductible for self-only coverage. Employer B has collectively bargained 
and non-collectively bargained employees. The collectively bargained 
employees are covered by a collective bargaining agreement under which 
health benefits were bargained in good faith. In the 2007 calendar year 
and in accordance with the terms of the collective bargaining agreement, 
Employer B contributes to the HSAs of all eligible collectively 
bargained employees. Employer B does not contribute to the HSAs of the 
non-collectively bargained employees. Employer B's contributions to the 
HSAs of collectively bargained employees are not subject to the 
comparability rules because the comparability rules do not apply to 
collectively bargained employees. Accordingly, Employer B's failure to 
contribute to the HSAs of the non-collectively bargained employees does 
not violate the comparability rules.
    Example 3. Employer C has two units of collectively bargained 
employees--unit Q and unit R--each covered by a collective bargaining 
agreement under which health benefits were bargained in good faith. In 
the 2007 calendar year and in accordance with the terms of the 
collective bargaining agreement, Employer C contributes to the HSAs of 
all eligible collectively bargained employees in unit Q. In accordance 
with the terms of the collective bargaining agreement, Employer C makes 
no HSA contributions for collectively bargained employees in unit R. 
Employer C's contributions to the HSAs of collectively bargained 
employees are not subject to the comparability rules because the 
comparability rules do not apply to collectively bargained employees.
    Example 4. Employer D has a unit of collectively bargained employees 
that are covered by a collective bargaining agreement under which health 
benefits were bargained in good faith. In accordance with the terms of 
the collective bargaining agreement, Employer D contributes an amount 
equal to a specified number of cents per hour for each hour worked to 
the HSAs of all eligible collectively bargained employees. Employer D's 
contributions to the HSAs of collectively bargained employees are not 
subject to the comparability rules because the comparability rules do 
not apply to collectively bargained employees.

    Q-7: Is an employer permitted to make comparable contributions only 
to the HSAs of comparable participating employees who have coverage 
under the employer's HDHP?

[[Page 369]]

    A-7: (a) Employer-provided HDHP coverage. If during a calendar year, 
an employer contributes to the HSA of any employee who is an eligible 
individual covered under an HDHP provided by the employer, the employer 
is required to make comparable contributions to the HSAs of all 
comparable participating employees with coverage under any HDHP provided 
by the employer. An employer that contributes only to the HSAs of 
employees who are eligible individuals with coverage under the 
employer's HDHP is not required to make comparable contributions to HSAs 
of employees who are eligible individuals but are not covered under the 
employer's HDHP.
    (b) Non-employer provided HDHP coverage. An employer that 
contributes to the HSA of any employee who is an eligible individual 
with coverage under any HDHP that is not an HDHP provided by the 
employer, must make comparable contributions to the HSAs of all 
comparable participating employees whether or not covered under the 
employer's HDHP. An employer that makes a reasonable good faith effort 
to identify all comparable participating employees with non-employer 
provided HDHP coverage and makes comparable contributions to the HSAs of 
such employees satisfies the requirements in paragraph (b) of this Q & 
A-7.
    (c) Examples. The following examples illustrate the rules in this Q 
& A-7. None of the employees in the following examples are covered by a 
collective bargaining agreement. The examples read as follows:

    Example 1. In a calendar year, Employer E offers an HDHP to its 
full-time employees. Most full-time employees are covered under Employer 
E's HDHP and Employer E makes comparable contributions only to these 
employees' HSAs. Employee W, a full-time employee of Employer E and an 
eligible individual, is covered under an HDHP provided by the employer 
of W's spouse and not under Employer E's HDHP. Employer E is not 
required to make comparable contributions to W's HSA.
    Example 2. In a calendar year, Employer F does not offer an HDHP. 
Several full-time employees of Employer F, who are eligible individuals, 
have HSAs. Employer F contributes to these employees' HSAs. Employer F 
must make comparable contributions to the HSAs of all full-time 
employees who are eligible individuals.
    Example 3. In a calendar year, Employer G offers an HDHP to its 
full-time employees. Most full-time employees are covered under Employer 
G's HDHP and Employer G makes comparable contributions to these 
employees' HSAs and also to the HSAs of full-time employees who are 
eligible individuals and who are not covered under Employer G's HDHP. 
Employee S, a full-time employee of Employer G and a comparable 
participating employee, is covered under an HDHP provided by the 
employer of S's spouse and not under Employer G's HDHP. Employer G must 
make comparable contributions to S's HSA.

    Q-8: If an employee and his or her spouse are eligible individuals 
who work for the same employer and one employee-spouse has family 
coverage for both employees under the employer's HDHP, must the employer 
make comparable contributions to the HSAs of both employees?
    A-8: (a) In general. If the employer makes contributions only to the 
HSAs of employees who are eligible individuals covered under its HDHP 
where only one employee-spouse has family coverage for both employees 
under the employer's HDHP, the employer is not required to contribute to 
the HSAs of both employee-spouses. The employer is required to 
contribute to the HSA of the employee-spouse with coverage under the 
employer's HDHP, but is not required to contribute to the HSA of the 
employee-spouse covered under the employer's HDHP by virtue of his or 
her spouse's coverage. However, if the employer contributes to the HSA 
of any employee who is an eligible individual with coverage under an 
HDHP that is not an HDHP provided by the employer, the employer must 
make comparable contributions to the HSAs of both employee-spouses if 
they are both eligible individuals. If an employer is required to 
contribute to the HSAs of both employee-spouses, the employer is not 
required to contribute amounts in excess of the annual contribution 
limits in section 223(b).
    (b) Examples. The following examples illustrate the rules in 
paragraph (a) of this Q & A-8. None of the employees in the following 
examples are covered by a collective bargaining agreement. The examples 
read as follows:


[[Page 370]]


    Example 1. In a calendar year, Employer H offers an HDHP to its 
full-time employees. Most full-time employees are covered under Employer 
H's HDHP and Employer H makes comparable contributions only to these 
employees' HSAs. T and U are a married couple. Employee T, who is a 
full-time employee of Employer H and an eligible individual, has family 
coverage under Employer H's HDHP for T and T's spouse. Employee U, who 
is also a full-time employee of Employer H and an eligible individual, 
does not have coverage under Employer H's HDHP except as the spouse of 
Employee T. Employer H is required to make comparable contributions to 
T's HSA, but is not required to make comparable contributions to U's 
HSA.
    Example 2. In a calendar year, Employer J offers an HDHP to its 
full-time employees. Most full-time employees are covered under Employer 
J's HDHP and Employer J makes comparable contributions to these 
employees' HSAs and to the HSAs of full-time employees who are eligible 
individuals but are not covered under Employer J's HDHP. R and S are a 
married couple. Employee S, who is a full-time employee of Employer J 
and an eligible individual, has family coverage under Employer J's HDHP 
for S and S's spouse. Employee R, who is also a full-time employee of 
Employer J and an eligible individual, does not have coverage under 
Employer J's HDHP except as the spouse of Employee S. Employer J must 
make comparable contributions to S's HSA and to R's HSA.

    Q-9: Does an employer that makes HSA contributions only for one 
class of non-collectively bargained employees who are eligible 
individuals, but not for another class of non-collectively bargained 
employees who are eligible individuals (for example, management v. non-
management) satisfy the requirement that the employer make comparable 
contributions?
    A-9: (a) Different classes of employees. No. If the two classes of 
employees are comparable participating employees, the comparability 
rules are not satisfied. The only categories of employees for 
comparability purposes are current full-time employees, current part-
time employees, and former employees. Collectively bargained employees 
are not comparable participating employees. But see Q & A-1 in 54.4980G-
5 on contributions made through a cafeteria plan. See Sec. 54.4980G-6 
for a special rule for contributions made to the HSAs of nonhighly 
compensated employees.
    (b) Examples. The following examples illustrate the rules in 
paragraph (a) of this Q & A-9. None of the employees in the following 
examples are covered by a collective bargaining agreement. The examples 
read as follows:

    Example 1. In a calendar year, Employer K maintains an HDHP covering 
all management and non-management employees. Employer K contributes to 
the HSAs of non-management employees who are eligible individuals 
covered under its HDHP. Employer K does not contribute to the HSAs of 
its management employees who are eligible individuals covered under its 
HDHP. The comparability rules are not satisfied.
    Example 2. All of Employer L's employees are located in city X and 
city Y. In a calendar year, Employer L maintains an HDHP for all 
employees working in city X only. Employer L does not maintain an HDHP 
for its employees working in city Y. Employer L contributes $500 to the 
HSAs of city X employees who are eligible individuals with coverage 
under its HDHP. Employer L does not contribute to the HSAs of any of its 
city Y employees. The comparability rules are satisfied because none of 
the employees in city Y are covered under an HDHP of Employer L. 
(However, if any employees in city Y were covered by an HDHP of Employer 
L, Employer L could not fail to contribute to their HSAs merely because 
they work in a different city.)
    Example 3. Employer M has two divisions--division N and division O. 
In a calendar year, Employer M maintains an HDHP for employees working 
in division N and division O. Employer M contributes to the HSAs of 
division N employees who are eligible individuals with coverage under 
its HDHP. Employer M does not contribute to the HSAs of division O 
employees who are eligible individuals covered under its HDHP. The 
comparability rules are not satisfied.
    Q-10: If an employer contributes to the HSAs of former employees who 
are eligible individuals, do the comparability rules apply to these 
contributions?
    A-10: (a) Former employees. Yes. The comparability rules apply to 
contributions an employer makes to former employees' HSAs. Therefore, if 
an employer contributes to any former employee's HSA, it must make 
comparable contributions to the HSAs of all comparable participating 
former employees (former employees who are eligible individuals with the 
same category of HDHP coverage). However, an employer is not required to 
make comparable contributions to the HSAs of former employees with 
coverage under the employer's HDHP because of an election under a COBRA 
continuation

[[Page 371]]

provision (as defined in section 9832(d)(1)). See Q & A-5 and Q & A-12 
of this section. The comparability rules apply separately to former 
employees because they are a separate category of covered employee. See 
Q & A-5 of this section. Also, former employees who were covered by a 
collective bargaining agreement immediately before termination of 
employment are not comparable participating employees. See Q & A-6 of 
this section.
    (b) Locating former employees. An employer making comparable 
contributions to former employees must take reasonable actions to locate 
any missing comparable participating former employees. In general, such 
actions include the use of certified mail, the Internal Revenue Service 
Letter Forwarding Program or the Social Security Administration's Letter 
Forwarding Service.
    (c) Examples. The following examples illustrate the rules in 
paragraph (a) of this Q & A-10. None of the employees in the following 
examples are covered by a collective bargaining agreement. The examples 
read as follows:

    Example 1. In a calendar year, Employer N contributes $1,000 for the 
calendar year to the HSA of each current employee who is an eligible 
individual with coverage under any HDHP. Employer N does not contribute 
to the HSA of any former employee who is an eligible individual. 
Employer N's contributions satisfy the comparability rules.
    Example 2. In a calendar year, Employer O contributes to the HSAs of 
current employees and former employees who are eligible individuals 
covered under any HDHP. Employer O contributes $750 to the HSA of each 
current employee with self-only HDHP coverage and $1,000 to the HSA of 
each current employee with family HDHP coverage. Employer O also 
contributes $300 to the HSA of each former employee with self-only HDHP 
coverage and $400 to the HSA of each former employee with family HDHP 
coverage. Employer O's contributions satisfy the comparability rules.

    Q-11: Is an employer permitted to make comparable contributions only 
to the HSAs of comparable participating former employees who have 
coverage under the employer's HDHP?
    A-11: If during a calendar year, an employer contributes to the HSA 
of any former employee who is an eligible individual covered under an 
HDHP provided by the employer, the employer is required to make 
comparable contributions to the HSAs of all former employees who are 
comparable participating former employees with coverage under any HDHP 
provided by the employer. An employer that contributes only to the HSAs 
of former employees who are eligible individuals with coverage under the 
employer's HDHP is not required to make comparable contributions to the 
HSAs of former employees who are eligible individuals and who are not 
covered under the employer's HDHP. However, an employer that contributes 
to the HSA of any former employee who is an eligible individual with 
coverage under an HDHP that is not an HDHP of the employer, must make 
comparable contributions to the HSAs of all former employees who are 
eligible individuals whether or not covered under an HDHP of the 
employer.
    Q-12: If an employer contributes only to the HSAs of former 
employees who are eligible individuals with coverage under the 
employer's HDHP, must the employer make comparable contributions to the 
HSAs of former employees who are eligible individuals with coverage 
under the employer's HDHP because of an election under a COBRA 
continuation provision (as defined in section 9832(d)(1))?
    A-12: No. An employer that contributes only to the HSAs of former 
employees who are eligible individuals with coverage under the 
employer's HDHP is not required to make comparable contributions to the 
HSAs of former employees who are eligible individuals with coverage 
under the employer's HDHP because of an election under a COBRA 
continuation provision (as defined in section 9832(d)(1)).
    Q-13: How do the comparability rules apply if some employees have 
HSAs and other employees have Archer MSAs?
    A-13: (a) HSAs and Archer MSAs. The comparability rules apply 
separately to employees who have HSAs and employees who have Archer 
MSAs. However, if an employee has both an HSA and an Archer MSA, the 
employer may contribute to either the HSA or the Archer MSA, but not to 
both.
    (b) Example. The following example illustrates the rules in 
paragraph (a) of this Q & A-13:


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    Example. In a calendar year, Employer P contributes $600 to the 
Archer MSA of each employee who is an eligible individual and who has an 
Archer MSA. Employer P contributes $500 for the calendar year to the HSA 
of each employee who is an eligible individual and who has an HSA. If an 
employee has both an Archer MSA and an HSA, Employer P contributes to 
the employee's Archer MSA and not to the employee's HSA. Employee X has 
an Archer MSA and an HSA. Employer P contributes $600 for the calendar 
year to X's Archer MSA but does not contribute to X's HSA. Employer P's 
contributions satisfy the comparability rules.

[T.D. 9277, 71 FR 43058, July 31, 2006, as amended by T.D. 9457, 74 FR 
45998, Sept. 8, 2009]



Sec. 54.4980G-4  Calculating comparable contributions.

    Q-1: What are comparable contributions?
    A-1: (a) Definition. Contributions are comparable if, for each month 
in a calendar year, the contributions are either the same amount or the 
same percentage of the deductible under the HDHP for employees who are 
eligible individuals with the same category of coverage on the first day 
of that month. Employees with self-only HDHP coverage are tested 
separately from employees with family HDHP coverage. Similarly, 
employees with different categories of family HDHP coverage may be 
tested separately. See Q & A-2 in Sec. 54.4980G-1. An employer is not 
required to contribute the same amount or the same percentage of the 
deductible for employees who are eligible individuals with one category 
of HDHP coverage that it contributes for employees who are eligible 
individuals with a different category of HDHP coverage. For example, an 
employer that satisfies the comparability rules by contributing the same 
amount to the HSAs of all employees who are eligible individuals with 
family HDHP coverage is not required to contribute any amount to the 
HSAs of employees who are eligible individuals with self-only HDHP 
coverage, or to contribute the same percentage of the self-only HDHP 
deductible as the amount contributed with respect to family HDHP 
coverage. However, the contribution with respect to the self plus two 
category may not be less than the contribution with respect to the self 
plus one category and the contribution with respect to the self plus 
three or more category may not be less than the contribution with 
respect to the self plus two category. But see Q & A-1 of Sec. 
54.4980G-6 for a special rule for contributions made to the HSAs of 
nonhighly compensated employees.
    (b) Examples. The following examples illustrate the rules in 
paragraph (a) of this Q & A-1. None of the employees in the following 
examples are covered by a collective bargaining agreement. The examples 
read as follows:

    Example 1. In the 2007 calendar year, Employer A offers its full-
time employees three health plans, including an HDHP with self-only 
coverage and a $2,000 deductible. Employer A contributes $1,000 for the 
calendar year to the HSA of each employee who is an eligible individual 
electing the self-only HDHP coverage. Employer A makes no HSA 
contributions for employees with family HDHP coverage or for employees 
who do not elect the employer's self-only HDHP. Employer A's HSA 
contributions satisfy the comparability rules.
    Example 2. In the 2007 calendar year, Employer B offers its 
employees an HDHP with a $3,000 deductible for self-only coverage and a 
$4,000 deductible for family coverage. Employer B contributes $1,000 for 
the calendar year to the HSA of each employee who is an eligible 
individual electing the self-only HDHP coverage. Employer B contributes 
$2,000 for the calendar year to the HSA of each employee who is an 
eligible individual electing the family HDHP coverage. Employer B's HSA 
contributions satisfy the comparability rules.
    Example 3. In the 2007 calendar year, Employer C offers its 
employees an HDHP with a $1,500 deductible for self-only coverage and a 
$3,000 deductible for family coverage. Employer C contributes $1,000 for 
the calendar year to the HSA of each employee who is an eligible 
individual electing the self-only HDHP coverage. Employer C contributes 
$1,000 for the calendar year to the HSA of each employee who is an 
eligible individual electing the family HDHP coverage. Employer C's HSA 
contributions satisfy the comparability rules.
    Example 4. In the 2007 calendar year, Employer D offers its 
employees an HDHP with a $1,500 deductible for self-only coverage and a 
$3,000 deductible for family coverage. Employer D contributes $1,500 for 
the calendar year to the HSA of each employee who is an eligible 
individual electing the self-only HDHP coverage. Employer D contributes 
$1,000 for the calendar year to the HSA of each employee who is an 
eligible individual

[[Page 373]]

electing the family HDHP coverage. Employer D's HSA contributions 
satisfy the comparability rules.
    Example 5. (i) In the 2007 calendar year, Employer E maintains two 
HDHPs. Plan A has a $2,000 deductible for self-only coverage and a 
$4,000 deductible for family coverage. Plan B has a $2,500 deductible 
for self-only coverage and a $4,500 deductible for family coverage. For 
the calendar year, Employer E makes contributions to the HSA of each 
full-time employee who is an eligible individual covered under Plan A of 
$600 for self-only coverage and $1,000 for family coverage. Employer E 
satisfies the comparability rules, if it makes either of the following 
contributions for the 2007 calendar year to the HSA of each full-time 
employee who is an eligible individual covered under Plan B--
    (A) $600 for each full-time employee with self-only coverage and 
$1,000 for each full-time employee with family coverage; or
    (B) $750 for each employee with self-only coverage and $1,125 for 
each employee with family coverage (the same percentage of the 
deductible Employer E contributes for full-time employees covered under 
Plan A, 30% of the deductible for self-only coverage and 25% of the 
deductible for family coverage).
    (ii) Employer E also makes contributions to the HSA of each part-
time employee who is an eligible individual covered under Plan A of $300 
for self-only coverage and $500 for family coverage. Employer E 
satisfies the comparability rules, if it makes either of the following 
contributions for the 2007 calendar year to the HSA of each part-time 
employee who is an eligible individual covered under Plan B--
    (A) $300 for each part-time employee with self-only coverage and 
$500 for each part-time employee with family coverage; or
    (B) $375 for each part-time employee with self-only coverage and 
$563 for each part-time employee with family coverage (the same 
percentage of the deductible Employer E contributes for part-time 
employees covered under Plan A, 15% of the deductible for self-only 
coverage and 12.5% of the deductible for family coverage).
    Example 6. (i) In the 2007 calendar year, Employer F maintains an 
HDHP. The HDHP has the following coverage options--
    (A) A $2,500 deductible for self-only coverage;
    (B) A $3,500 deductible for self plus one dependent (self plus one);
    (C) A $3,500 deductible for self plus spouse (self plus one);
    (D) A $3,500 deductible for self plus spouse and one dependent (self 
plus two); and
    (E) A $3,500 deductible for self plus spouse and two or more 
dependents (self plus three or more).
    (ii) Employer F makes the following contributions for the calendar 
year to the HSA of each full-time employee who is an eligible individual 
covered under the HDHP--
    (A) $750 for self-only coverage;
    (B) $1,000 for self plus one dependent;
    (C) $1,000 for self plus spouse;
    (D) $1,500 for self plus spouse and one dependent; and
    (E) $2,000 for self plus spouse and two or more dependents.
    (iii) Employer F's HSA contributions satisfy the comparability 
rules.
    Example 7. (i) In a calendar year, Employer G offers its employees 
an HDHP and a health flexible spending arrangement (health FSA). The 
health FSA reimburses employees for medical expenses as defined in 
section 213(d). Some of Employer G's employees have coverage under the 
HDHP and the health FSA, some have coverage under the HDHP and their 
spouse's FSA, and some have coverage under the HDHP and are enrolled in 
Medicare. For the calendar year, Employer G contributes $500 to the HSA 
of each employee who is an eligible individual. No contributions are 
made to the HSAs of employees who have coverage under Employer G's 
health FSA or under a spouse's health FSA or who are enrolled in 
Medicare.
    (ii) The employees who have coverage under a health FSA (whether 
Employer H's or their spouse's FSA) or who are covered under Medicare 
are not eligible individuals. Specifically, the employees who have 
coverage under the health FSA or under a spouse's health FSA are not 
comparable participating employees because they are not eligible 
individuals under section 223(c)(1). Similarly, the employees who are 
enrolled in Medicare are not comparable participating employees because 
they are not eligible individuals under section 223(b)(7) and (c)(1). 
Therefore, employees who have coverage under the health FSA or under a 
spouse's health FSA and employees who are enrolled in Medicare are 
excluded from comparability testing. See sections 4980G(b) and 4980E. 
Employer G's contributions satisfy the comparability rules.

    Q-2: How does an employer comply with the comparability rules when 
some non-collectively bargained employees who are eligible individuals 
do not work for the employer during the entire calendar year?
    A-2: (a) In general. In determining whether the comparability rules 
are satisfied, an employer must take into account all full-time and 
part-time employees who were employees and eligible individuals for any 
month during the calendar year. (Full-time and part-time employees are 
tested separately. See Q & A-5 in Sec. 54.4980G-3.) There are

[[Page 374]]

two methods to comply with the comparability rules when some employees 
who are eligible individuals do not work for the employer during the 
entire calendar year; contributions may be made on a pay-as-you-go basis 
or on a look-back basis. See Q & A-9 through Q & A-11 in Sec. 54.4980G-
3 for the rules regarding comparable contributions to the HSAs of former 
employees.
    (b) Contributions on a pay-as-you-go basis. An employer may comply 
with the comparability rules by contributing amounts at one or more 
dates during the calendar year to the HSAs of employees who are eligible 
individuals as of the first day of the month, if contributions are the 
same amount or the same percentage of the HDHP deductible for employees 
who are eligible individuals as of the first day of the month with the 
same category of coverage and are made at the same time. Contributions 
made at the employer's usual payroll interval for different groups of 
employees are considered to be made at the same time. For example, if 
salaried employees are paid monthly and hourly employees are paid bi-
weekly, an employer may contribute to the HSAs of hourly employees on a 
bi-weekly basis and to the HSAs of salaried employees on a monthly 
basis. An employer may change the amount that it contributes to the HSAs 
of employees at any point. However, the changed contribution amounts 
must satisfy the comparability rules.
    (c) Examples. The following examples illustrate the rules in 
paragraph (b) of this Q & A-2: The examples read as follows:

    Example 1. (i) Beginning on January 1st, Employer H contributes $50 
per month on the first day of each month to the HSA of each employee who 
is an eligible individual on that date. Employer H does not contribute 
to the HSAs of former employees. In mid-March of the same year, Employee 
X, an eligible individual, terminates employment after Employer H has 
contributed $150 to X's HSA. After X terminates employment, Employer H 
does not contribute additional amounts to X's HSA. In mid-April of the 
same year, Employer H hires Employee Y, an eligible individual, and 
contributes $50 to Y's HSA in May and $50 in June. Effective in July of 
the same year, Employer H stops contributing to the HSAs of all 
employees and makes no contributions to the HSA of any employee for the 
months of July through December. In August, Employer H hires Employee Z, 
an eligible individual. Employer H does not contribute to Z's HSA. After 
Z is hired, Employer H does not hire additional employees. As of the end 
of the calendar year, Employer H has made the following HSA 
contributions to its employees' HSAs--
    (A) Employer H contributed $150 to X's HSA;
    (B) Employer H contributed $100 to Y's HSA;
    (C) Employer H did not contribute to Z's HSA; and
    (D) Employer H contributed $300 to the HSA of each employee who was 
an eligible individual and employed by Employer J from January through 
June.
    (ii) Employer H's contributions satisfy the comparability rules.
    Example 2. In a calendar year, Employer J offers its employees an 
HDHP and contributes on a monthly pay-as-you-go basis to the HSAs of 
employees who are eligible individuals with coverage under Employer J's 
HDHP. In the calendar year, Employer J contributes $50 per month to the 
HSA of each employee with self-only HDHP coverage and $100 per month to 
the HSA of each employee with family HDHP coverage. From January 1st 
through March 31st of the calendar year, Employee X is an eligible 
individual with self-only HDHP coverage. From April 1st through December 
31st of the calendar year, X is an eligible individual with family HDHP 
coverage. For the months of January, February and March of the calendar 
year, Employer J contributes $50 per month to X's HSA. For the remaining 
months of the calendar year, Employer J contributes $100 per month to 
X's HSA. Employer J's contributions to X's HSA satisfy the comparibility 
rules.

    (d) Contributions on a look-back basis. An employer may also satisfy 
the comparability rules by determining comparable contributions for the 
calendar year at the end of the calendar year, taking into account all 
employees who were eligible individuals for any month during the 
calendar year and contributing the same percentage of the HDHP 
deductible or the same dollar amount to the HSAs of all employees with 
the same category of coverage for that month.
    (e) Examples. The following examples illustrate the rules in 
paragraph (d) of this Q & A-2. The examples read as follows:

    Example 1. In a calendar year, Employer K offers its employees an 
HDHP and contributes on a look-back basis to the HSAs of employees who 
are eligible individuals with

[[Page 375]]

coverage under Employer K's HDHP. Employer K contributes $600 ($50 per 
month) for the calendar year to the HSA of each employee with self-only 
HDHP coverage and $1,200 ($100 per month) for the calendar year to the 
HSA of each employee with family HDHP coverage. From January 1st through 
June 30th of the calendar year, Employee Y is an eligible individual 
with family HDHP coverage. From July 1st through December 31st, Y is an 
eligible individual with self-only HDHP coverage. Employer K contributes 
$900 on a look-back basis for the calendar year to Y's HSA ($100) per 
month for the months of January through June and $50 per month for the 
months of July through December. Employer K's contributions to Y's HSA 
satisfy the comparability rules.
    Example 2. On December 31st, Employer L contributes $50 per month on 
a look-back basis to each employee's HSA for each month in the calendar 
year that the employee was an eligible individual. In mid-March of the 
same year, Employee T, an eligible individual, terminated employment. In 
mid-April of the same year, Employer L hired Employee U, who becomes an 
eligible individual as of May 1st and works for Employer L through 
December 31st. On December 31st, Employer L contributes $150 to Employee 
T's HSA and $400 to Employee U's HSA. Employer L's contributions satisfy 
the comparability rules.

    (f) Periods and dates for making contributions. With both the pay-
as-you-go method and the look-back method, an employer may establish, on 
a reasonable and consistent basis, periods for which contributions will 
be made (for example, a quarterly period covering three consecutive 
months in a calendar year) and the dates on which such contributions 
will be made for that designated period (for example, the first day of 
the quarter or the last day of the quarter in the case of an employer 
who has established a quarterly period for making contributions). An 
employer that makes contributions on a pay-as-you-go basis for a period 
covering more than one month will not fail to satisfy the comparability 
rules because an employee who terminates employment prior to the end of 
the period for which contributions were made has received more 
contributions on a monthly basis than employees who have worked the 
entire period. In addition, an employer that makes contributions on a 
pay-as-you-go basis for a period covering more than one month must make 
HSA contributions for any comparable participating employees hired after 
the date of initial funding for that period.
    (g) Example. The following example illustrates the rules in 
paragraph (f) of this Q & A-2:

    Example. Employer M has established, on a reasonable and consistent 
basis, a quarterly period for making contributions to the HSAs of 
eligible employees on a pay-as-you-go basis. Beginning on January 1st, 
Employer M contributes $150 for the first three months of the calendar 
year to the HSA of each employee who is an eligible individual on that 
date. On January 15th, Employee V, an eligible individual, terminated 
employment after Employer M has contributed $150 to V's HSA. On January 
15th, Employer M hired Employee W, who becomes an eligible individual as 
of February 1st. On April 1st, Employer M has contributed $100 to W's 
HSA for the two months (February and March) in the quarter period that 
Employee W was an eligible employee. Employer M's contributions satisfy 
the comparability rules.

    (h) Maximum contribution permitted for all employees who are 
eligible individuals during the last month of the taxable year. An 
employer may contribute up to the maximum annual contribution amount for 
the calendar year (based on the employees' HDHP coverage) to the HSAs of 
all employees who are eligible individuals on the first day of the last 
month of the employees' taxable year, including employees who worked for 
the employer for less than the entire calendar year and employees who 
became eligible individuals after January 1st of the calendar year. For 
example, such contribution may be made on behalf of an eligible 
individual who is hired after January 1st or an employee who becomes an 
eligible individual after January 1st. Employers are not required to 
provide more than a pro-rata contribution based on the number of months 
that an individual was an eligible individual and employed by the 
employer during the year. However, if an employer contributes more than 
a pro-rata amount for the calendar year to the HSA of any eligible 
individual who is hired after January 1st of the calendar year or any 
employee who becomes an eligible individual any time after January 1st 
of the calendar year, the employer must contribute that same amount on 
an equal and uniform basis to the HSAs of all comparable

[[Page 376]]

participating employees (as defined in Q & A-1 in Sec. 54.4980G-1) who 
are hired or become eligible individuals after January 1st of the 
calendar year. Likewise, if an employer contributes the maximum annual 
contribution amount for the calendar year to the HSA of any eligible 
individual who is hired after January 1st of the calendar year or any 
employee who becomes an eligible individual any time after January 1st 
of the calendar year, the employer must contribute the maximum annual 
contribution amount on an equal and uniform basis to the HSAs of all 
comparable participating employees (as defined in Q & A-1 in Sec. 
54.4980G-1) who are hired or become eligible individuals after January 
1st of the calendar year. An employer who makes the maximum calendar 
year contribution or more than a pro-rata contribution to the HSAs of 
employees who become eligible individuals after the first day of the 
calendar year or eligible individuals who are hired after the first day 
of the calendar year will not fail to satisfy comparability merely 
because some employees will have received more contributions on a 
monthly basis than employees who worked the entire calendar year.
    (i) Examples. The following examples illustrate the rules in 
paragraph (h) in this Q & A-2. In the following examples, no 
contributions are made through a section 125 cafeteria plan and none of 
the employees are covered by a collective bargaining agreement.

    Example 1. On January 1, 2010, Employer Q contributes $1,000 for the 
calendar year to the HSAs of employees who are eligible individuals with 
family HDHP coverage. In mid-March of the same year, Employer Q hires 
Employee A, an eligible individual with family HDHP coverage. On April 
1, 2010, Employer Q contributes $1,000 to the HSA of Employee A. In 
September of the same year, Employee B becomes an eligible individual 
with family HDHP coverage. On October 1, 2010, Employer G contributes 
$1,000 to the HSA of Employee B. Employer Q does not make any other 
contributions for the 2010 calendar year. Employer Q's contributions 
satisfy the comparability rules.
    Example 2. For the 2010 calendar year, Employer R only has two 
employees, Employee C and Employee D. Employee C, an eligible individual 
with family HDHP coverage, works for Employer R for the entire calendar 
year. Employee D, an eligible individual with family HDHP coverage works 
for Employer R from July 1st through December 31st. Employer R 
contributes $1,200 for the calendar year to the HSA of Employee C and 
$600 to the HSA of Employee D. Employer R does not make any other 
contributions for the 2010 calendar year. Employer R's contributions 
satisfy the comparability rules.

    (j) Effective/applicability date. The rules in paragraphs (h) and 
(i) of Q & A-2 are effective for employer contributions made for 
calendar years beginning on or after January 1, 2010.

    Q-3: How do the comparability rules apply to employer contributions 
to employees' HSAs if some non-collectively bargained employees work 
full-time during the entire calendar year, and other non-collectively 
bargained employees work full-time for less than the entire calendar 
year?
    A-3: Employer contributions to the HSAs of employees who work full-
time for less than twelve months satisfy the comparability rules if the 
contribution amount is comparable when determined on a month-to-month 
basis. For example, if the employer contributes $240 to the HSA of each 
full-time employee who works the entire calendar year, the employer must 
contribute $60 to the HSA of each full-time employee who works on the 
first day of each three months of the calendar year. The rules set forth 
in this Q & A-2 apply to employer contributions made on a pay-as-you-go 
basis or on a look-back basis as described in Q & A-3 of this section. 
See sections 4980G(b) and 4980E(d)(2)(B).
    Q-4: May an employer make contributions for the entire year to the 
HSAs of its employees who are eligible individuals at the beginning of 
the calendar year (on a pre-funded basis) instead of contributing on a 
pay-as-you-go or on a look-back basis?
    A-4: (a) Contributions on a pre-funded basis. Yes. An employer may 
make contributions for the entire year to the HSAs of its employees who 
are eligible individuals at the beginning of the calendar year. An 
employer that pre-funds the HSAs of its employees will not fail to 
satisfy the comparability rules because an employee who terminates 
employment prior to the end of the calendar year has received more 
contributions on a monthly basis than employees who work the entire 
calendar year.

[[Page 377]]

See Q & A-12 of this section. Under section 223(d)(1)(E), an account 
beneficiary's interest in an HSA is nonforfeitable. An employer must 
make comparable contributions for all employees who are comparable 
participating employees for any month during the calendar year, 
including employees who are eligible individuals hired after the date of 
initial funding. An employer that makes HSA contributions on a pre-
funded basis may also contribute on a pre-funded basis to the HSAs of 
employees who are eligible individuals hired after the date of initial 
funding. Alternatively, an employer that has pre-funded the HSAs of 
comparable participating employees may contribute to the HSAs of 
employees who are eligible individuals hired after the date of initial 
funding on a pay-as-you-go basis or on a look-back basis. An employer 
that makes HSA contributions on a pre-funded basis must use the same 
contribution method for all employees who are eligible individuals hired 
after the date of initial funding.
    (b) Example. The following example illustrates the rules in 
paragraph (a) of this Q & A-4:

    Example. (i) On January 1, Employer N contributes $1,200 for the 
calendar year on a pre-funded basis to the HSA of each employee who is 
an eligible individual. In mid-May, Employer N hires Employee B, who 
becomes an eligible individual as of June 1st. Therefore, Employer N is 
required to make comparable contributions to B's HSA beginning in June. 
Employer N satisfies the comparability rules with respect to 
contributions to B's HSA if it makes HSA contributions in any one of the 
following ways--
    (A) Pre-funding B's HSA by contributing $700 to B's HSA;
    (B) Contributing $100 per month on a pay-as-you-go basis to B's HSA; 
or
    (C) Contributing to B's HSA at the end of the calendar year taking 
into account each month that B was an eligible individual and employed 
by Employer M.
    (ii) If Employer M hires additional employees who are eligible 
individuals after initial funding, it must use the same contribution 
method for these employees that it used to contribute to B's HSA.

    Q-5: Must an employer use the same contribution method as described 
in Q & A-2 and Q & A-4 of this section for all employees who were 
comparable participating employees for any month during the calendar 
year?
    A-5: Yes. If an employer makes comparable HSA contributions on a 
pay-as-you-go basis, it must do so for each employee who is a comparable 
participating employee as of the first day of the month. If an employer 
makes comparable contributions on a look-back basis, it must do so for 
each employee who was a comparable participating employee for any month 
during the calendar year. If an employer makes HSA contributions on a 
pre-funded basis, it must do so for all employees who are comparable 
participating employees at the beginning of the calendar year and must 
make comparable HSA contributions for all employees who are comparable 
participating employees for any month during the calendar year, 
including employees who are eligible individuals hired after the date of 
initial funding. See Q & A-4 of this section for rules regarding 
contributions for employees hired after initial funding.
    Q-6: How does an employer comply with the comparability rules if an 
employee has not established an HSA at the time the employer contributes 
to its employees' HSAs?
    A-6: (a) Employee has not established an HSA at the time the 
employer funds its employees' HSAs. If an employee has not established 
an HSA at the time the employer funds its employees' HSAs, the employer 
complies with the comparability rules by contributing comparable amounts 
plus reasonable interest to the employee's HSA when the employee 
establishes the HSA, taking into account each month that the employee 
was a comparable participating employee. See Q & A-13 of this section 
for rules regarding reasonable interest.
    (b) Example. The following example illustrates the rules in 
paragraph (a) of this Q & A-6:

    Example. Beginning on January 1st, Employer O contributes $500 per 
calendar year on a pay-as-you-go basis to the HSA of each employee who 
is an eligible individual. Employee C is an eligible individual during 
the entire calendar year but does not establish an HSA until March. 
Notwithstanding C's delay in establishing an HSA, Employer O must make 
up the missed HSA contributions plus reasonable interest for January and

[[Page 378]]

February by April 15th of the following calendar year.
    Q-7: If an employer bases its contributions on a percentage of the 
HDHP deductible, how is the correct percentage or dollar amount 
computed?
    A-7: (a) Computing HSA contributions. The correct percentage is 
determined by rounding to the nearest 1/100th of a percentage point and 
the dollar amount is determined by rounding to the nearest whole dollar.
    (b) Example. The following example illustrates the rules in 
paragraph (a) of this Q & A-7:

    Example. In this Example, assume that each HDHP provided by Employer 
P satisfies the definition of an HDHP for the 2007 calendar year. In the 
2007 calendar year, Employer P maintains two HDHPs. Plan A has a 
deductible of $3,000 for self-only coverage. Employer P contributes 
$1,000 for the calendar year to the HSA of each employee covered under 
Plan A. Plan B has a deductible of $3,500 for self-only coverage. 
Employer P satisfies the comparability rules if it makes either of the 
following contributions for the 2007 calendar year to the HSA of each 
employee who is an eligible individual with self-only coverage under 
Plan B--
    (i) $1,000; or
    (ii) $1,167 (33.33% of the deductible rounded to the nearest whole 
dollar amount).

    Q-8: Does an employer that contributes to the HSA of each comparable 
participating employee in an amount equal to the employee's HSA 
contribution or a percentage of the employee's HSA contribution 
(matching contributions) satisfy the rule that all comparable 
participating employees receive comparable contributions?
    A-8: No. If all comparable participating employees do not contribute 
the same amount to their HSAs and, consequently, do not receive 
comparable contributions to their HSAs, the comparability rules are not 
satisfied, notwithstanding that the employer offers to make available 
the same contribution amount to each comparable participating employee. 
But see Q & A-1 in Sec. 54.4980G-5 on contributions to HSAs made 
through a cafeteria plan.
    Q-9: If an employer conditions contributions by the employer to an 
employee's HSA on an employee's participation in health assessments, 
disease management programs or wellness programs and makes the same 
contributions available to all employees who participate in the 
programs, do the contributions satisfy the comparability rules?
    A-9: No. If all comparable participating employees do not elect to 
participate in all the programs and consequently, all comparable 
participating employees do not receive comparable contributions to their 
HSAs, the employer contributions fail to satisfy the comparability 
rules. But see Q & A-1 in Sec. 54.4980G-5 on contributions made to HSAs 
through a cafeteria plan.
    Q-10: If an employer makes additional contributions to the HSAs of 
all comparable participating employees who have attained a specified age 
or who have worked for the employer for a specified number of years, do 
the contributions satisfy the comparability rules?
    A-10: No. If all comparable participating employees do not meet the 
age or length of service requirement, all comparable participating 
employees do not receive comparable contributions to their HSAs and the 
employer contributions fail to satisfy the comparability rules.
    Q-11: If an employer makes additional contributions to the HSAs of 
all comparable participating employees who are eligible to make the 
additional contributions (HSA catch-up contributions) under section 
223(b)(3), do the contributions satisfy the comparability rules?
    A-11: No. If all comparable participating employees are not eligible 
to make the additional HSA contributions under section 223(b)(3), all 
comparable participating employees do not receive comparable 
contributions to their HSAs, and the employer contributions fail to 
satisfy the comparability rules.
    Q-12: If an employer's contributions to an employee's HSA result in 
non-comparable contributions, may the employer recoup the excess amount 
from the employee's HSA?
    A-12: No. An employer may not recoup from an employee's HSA any 
portion of the employer's contribution to the employee's HSA. Under 
section 223(d)(1)(E), an account beneficiary's interest in an HSA is 
nonforfeitable.

[[Page 379]]

However, an employer may make additional HSA contributions to satisfy 
the comparability rules. An employer may contribute up until April 15th 
following the calendar year in which the non-comparable contributions 
were made. An employer that makes additional HSA contributions to 
correct non-comparable contributions must also contribute reasonable 
interest. However, an employer is not required to contribute amounts in 
excess of the annual contribution limits in section 223(b). See Q & A-13 
of this section for rules regarding reasonable interest.
    Q-13: What constitutes a reasonable interest rate for purposes of 
making comparable contributions?
    A-13: The determination of whether a rate of interest used by an 
employer is reasonable will be based on all of the facts and 
circumstances. If an employer calculates interest using the Federal 
short-term rate as determined by the Secretary in accordance with 
section 1274(d), the employer is deemed to use a reasonable interest 
rate.
    Q-14: Does an employer fail to satisfy the comparability rules for a 
calendar year if the employer fails to make contributions with respect 
to eligible employees because the employee has not established an HSA or 
because the employer does not know that the employee has established an 
HSA?
    A-14: (a) In general. An employer will not fail to satisfy the 
comparability rules for a calendar year (Year 1) merely because the 
employer fails to make contributions with respect to an eligible 
employee because the employee has not established an HSA or because the 
employer does not know that the employee has established an HSA, if--
    (1) The employer provides timely written notice to all such eligible 
employees that it will make comparable contributions for Year 1 for 
eligible employees who, by the last day of February of the following 
calendar year (Year 2), both establish an HSA and notify the employer 
(in accordance with a procedure specified in the notice) that they have 
established an HSA; and
    (2) For each such eligible employee who establishes an HSA and so 
notifies the employer on or before the last day of February of Year 2, 
the employer contributes to the HSA for Year 1 comparable amounts 
(taking into account each month that the employee was a comparable 
participating employee) plus reasonable interest by April 15th of Year 
2.
    (b) Notice. The notice described in paragraph (a) of this Q & A-14 
must be provided to each eligible employee who has not established an 
HSA by December 31 of Year 1 or if the employer does not know if the 
employee established an HSA. The employer may provide the notice to 
other employees as well. However, if an employee has earlier notified 
the employer that he or she has established an HSA, or if the employer 
has previously made contributions to that employee's HSA, the employer 
may not condition making comparable contributions on receipt of any 
additional notice from that employee. For each calendar year, a notice 
is deemed to be timely if the employer provides the notice no earlier 
than 90 days before the first HSA employer contribution for that 
calendar year and no later than January 15 of the following calendar 
year.
    (c) Model notice. Employers may use the following sample language as 
a basis in preparing their own notices.

Notice to Employees Regarding Employer Contributions to HSAs:

    This notice explains how you may be eligible to receive 
contributions from [employer] if you are covered by a High Deductible 
Health Plan (HDHP). [Employer] provides contributions to the Health 
Savings Account (HSA) of each employee who is [insert employer's 
eligibility requirements for HSA contributions] (``eligible employee''). 
If you are an eligible employee, you must do the following in order to 
receive an employer contribution:
    (1) Establish an HSA on or before the last day in February of 
[insert year after the year for which the contribution is being made] 
and;
    (2) Notify [insert name and contact information for appropriate 
person to be contacted] of your HSA account information on or before the 
last day in February of [insert year after year for which the 
contribution is being made]. [Specify the HSA account information that 
the employee must provide (e.g., account number, name and address of 
trustee or custodian, etc.) and the method by which the employee must 
provide this account information (e.g., in writing, by e-mail, on a 
certain form, etc.)].
    If you establish your HSA on or before the last day of February in 
[insert year after

[[Page 380]]

year for which the contribution is being made] and notify [employer] of 
your HSA account information, you will receive your HSA contributions, 
plus reasonable interest, for [insert year for which contribution is 
being made] by April 15 of [insert year after year for which 
contribution is being made]. If, however, you do not establish your HSA 
or you do not notify us of your HSA account information by the deadline, 
then we are not required to make any contributions to your HSA for 
[insert applicable year]. You may notify us that you have established an 
HSA by sending an [e-mail or] a written notice to [insert name, title 
and, if applicable, e-mail address]. If you have any questions about 
this notice, you can contact [insert name and title] at [insert 
telephone number or other contact information].

    (d) [Reserved]
    (e) Electronic delivery. An employer may furnish the notice required 
under this section electronically in accordance with Sec. 1.401(a)-21 
of this chapter.
    (f) Examples. The following examples illustrate the rules in this Q 
& A-14:

    Example 1. In a calendar year, Employer Q contributes to the HSAs of 
current employees who are eligible individuals covered under any HDHP. 
For the 2009 calendar year, Employer Q contributes $50 per month on the 
first day of each month, beginning January 1st, to the HSA of each 
employee who is an eligible employee on that date. For the 2009 calendar 
year, Employer Q provides written notice satisfying the content 
requirements of this Q & A-14 on October 16, 2008 to all employees 
regarding the availability of HSA contributions for eligible employees. 
For eligible employees who are hired after October 16, 2008, Employer Q 
provides such a notice no later than January 15, 2010. Employer Q's 
notice satisfies the notice timing requirements in paragraph (a)(1) of 
this Q & A-14.
    Example 2. Employer R's written cafeteria plan permits employees to 
elect to make pre-tax salary reduction contributions to their HSAs. 
Employees making this election have the right to receive cash or other 
taxable benefits in lieu of their HSA pre-tax contribution. Employer R 
automatically contributes a non-elective matching contribution to the 
HSA of each employee who makes a pre-tax HSA contribution. Because 
Employer R's HSA contributions are made through the cafeteria plan, the 
comparability requirements do not apply to the HSA contributions made by 
Employer R. Consequently, Employer R is not required to provide written 
notice to its employees regarding the availability of this matching HSA 
contribution. See Q & A-1 in Sec. 54.4980G-5 for treatment of HSA 
contributions made through a cafeteria plan.
    Example 3. In a calendar year, Employer S maintains an HDHP and only 
contributes to the HSAs of eligible employees who elect coverage under 
its HDHP. For the 2009 calendar year, Employer S employs ten eligible 
employees and all ten employees have elected coverage under Employer S's 
HDHP and have established HSAs. For the 2009 calendar year, Employer S 
makes comparable contributions to the HSAs of all ten employees. 
Employer S satisfies the comparability rules. Thus, Employer S is not 
required to provide written notice to its employees regarding the 
availability of HSA contributions for eligible employees.
    Example 4. In a calendar year, Employer T contributes to the HSAs of 
current full-time employees with family coverage under any HDHP. For the 
2009 calendar year, Employer T provides timely written notice satisfying 
the content requirements of this section to all employees regardless of 
HDHP coverage. Employer T makes identical monthly contributions to all 
eligible employees (meaning full time employees with family HDHP 
coverage) that establish HSAs. Employer T contributes comparable amounts 
(taking into account each month that the employee was a comparable 
participating employee) plus reasonable interest to the HSAs of the 
eligible employees that establish HSAs and provide the necessary 
information after the end of the year but on or before the last day of 
February, 2010. Employer T makes no contribution to the HSAs of 
employees that do not establish an HSA or that do not provide the 
necessary information on or before the last day of February, 2010. 
Employer T satisfies the comparability requirements.
    Example 5. For the 2009 calendar year, Employer V contributes to the 
HSAs of current full time employees with family coverage under any HDHP. 
Employer V has 500 current full time employees. As of the date for 
Employer V's first HSA contribution for the 2009 calendar year, 450 
eligible employees have established HSAs. Employer V provides timely 
written notice satisfying the content requirements of this section only 
to those 50 eligible employees who have not established HSAs. Employer V 
makes identical quarterly contributions to the 450 eligible employees 
who established HSAs. By April 15, 2010, Employer V contributes 
comparable amounts to the other eligible employees who establish HSAs 
and provide the necessary information on or before the last day of 
February, 2010. Employer V makes no contribution to the HSAs of eligible 
employees that do not establish an HSA or that do not provide the 
necessary information on or before the last day of February, 2010. 
Employer V satisfies the comparability rules.

    Q-15: For any calendar year, may an employer accelerate part or all 
of its contributions for the entire year to the

[[Page 381]]

HSAs of employees who have incurred, during the calendar year, qualified 
medical expenses (as defined in section 223(d)(2)) exceeding the 
employer's cumulative HSA contributions at that time?
    A-15: (a) In general. Yes. For any calendar year, an employer may 
accelerate part or all of its contributions for the entire year to the 
HSAs of employees who have incurred, during the calendar year, qualified 
medical expenses exceeding the employer's cumulative HSA contributions 
at that time. If an employer accelerates contributions to the HSA of any 
such eligible employee, all accelerated contributions must be available 
throughout the calendar year on an equal and uniform basis to all such 
eligible employees. Employers must establish reasonable uniform methods 
and requirements for accelerated contributions and the determination of 
medical expenses.
    (b) Satisfying comparability. An employer that accelerates 
contributions to the HSAs of its employees will not fail to satisfy the 
comparability rules because employees who incur qualifying medical 
expenses exceeding the employer's cumulative HSA contributions at that 
time have received more contributions in a given period than comparable 
employees who do not incur such expenses, provided that all comparable 
employees receive the same amount or the same percentage for the 
calendar year. Also, an employer that accelerates contributions to the 
HSAs of its employees will not fail to satisfy the comparability rules 
because an employee who terminates employment prior to the end of the 
calendar year has received more contributions on a monthly basis than 
employees who work the entire calendar year. An employer is not required 
to contribute reasonable interest on either accelerated or non-
accelerated HSA contributions. But see Q & A-6 and Q & A-12 of this 
section for when reasonable interest must be paid.
    Q-16: What is the effective date for the rules in Q & A-14 and Q & 
A-15 of this section?
    A-16: These regulations apply to employer contributions made for 
calendar years beginning on or after January 1, 2009.

[T.D. 9277, 71 FR 43058, July 31, 2006; 71 FR 53967, Sept. 13, 2006, as 
amended by T.D. 9393, 73 FR 20795, Apr. 17, 2008; T.D. 9457, 74 FR 
45998, Sept. 8, 2009]



Sec. 54.4980G-5  HSA comparability rules and cafeteria plans and waiver
of excise tax.

    Q-1: If an employer makes contributions through a section 125 
cafeteria plan to the HSA of each employee who is an eligible 
individual, are the contributions subject to the comparability rules?
    A-1: (a) In general. No. The comparability rules do not apply to HSA 
contributions that an employer makes through a section 125 cafeteria 
plan. However, contributions to an HSA made through a cafeteria plan are 
subject to the section 125 nondiscrimination rules (eligibility rules, 
contributions and benefits tests and key employee concentration tests). 
See section 125(b), (c) and (g) and the regulations thereunder.
    (b) Contributions made through a section 125 cafeteria plan. 
Employer contributions to employees' HSAs are made through a section 125 
cafeteria plan and are subject to the section 125 cafeteria plan 
nondiscrimination rules and not the comparability rules if under the 
written cafeteria plan, the employees have the right to elect to receive 
cash or other taxable benefits in lieu of all or a portion of an HSA 
contribution (meaning that all or a portion of the HSA contributions are 
available as pre-tax salary reduction amounts), regardless of whether an 
employee actually elects to contribute any amount to the HSA by salary 
reduction.
    Q-2: If an employer makes contributions through a cafeteria plan to 
the HSA of each employee who is an eligible individual in an amount 
equal to the amount of the employee's HSA contribution or a percentage 
of the amount of the employee's HSA contribution (matching 
contributions), are the contributions subject to the section 4980G 
comparability rules?
    A-2: No. The comparability rules do not apply to HSA contributions 
that an employer makes through a section 125

[[Page 382]]

cafeteria plan. Thus, where matching contributions are made by an 
employer through a cafeteria plan, the contributions are not subject to 
the comparability rules of section 4980G. However, contributions, 
including matching contributions, to an HSA made under a cafeteria plan 
are subject to the section 125 nondiscrimination rules (eligibility 
rules, contributions and benefits tests and key employee concentration 
tests). See Q & A-1 of this section.
    Q-3: If under the employer's cafeteria plan, employees who are 
eligible individuals and who participate in health assessments, disease 
management programs or wellness programs receive an employer 
contribution to an HSA and the employees have the right to elect to make 
pre-tax salary reduction contributions to their HSAs, are the 
contributions subject to the comparability rules?
    A-3: (a) In general. No. The comparability rules do not apply to 
employer contributions to an HSA made through a cafeteria plan. See Q & 
A-1 of this section.
    (b) Examples. The following examples illustrate the rules in this 
Sec. 54.4980G-5. The examples read as follows:

    Example 1. Employer A's written cafeteria plan permits employees to 
elect to make pre-tax salary reduction contributions to their HSAs. 
Employees making this election have the right to receive cash or other 
taxable benefits in lieu of their HSA pre-tax contribution. The section 
125 cafeteria plan nondiscrimination rules and not the comparability 
rules apply because the HSA contributions are made through the cafeteria 
plan.
    Example 2. Employer B's written cafeteria plan permits employees to 
elect to make pre-tax salary reduction contributions to their HSAs. 
Employees making this election have the right to receive cash or other 
taxable benefits in lieu of their HSA pre-tax contribution. Employer B 
automatically contributes a non-elective matching contribution or seed 
money to the HSA of each employee who makes a pre-tax HSA contribution. 
The section 125 cafeteria plan nondiscrimination rules and not the 
comparability rules apply to Employer B's HSA contributions because the 
HSA contributions are made through the cafeteria plan.
    Example 3. Employer C's written cafeteria plan permits employees to 
elect to make pre-tax salary reduction contributions to their HSAs. 
Employees making this election have the right to receive cash or other 
taxable benefits in lieu of their HSA pre-tax contribution. Employer C 
makes a non-elective contribution to the HSAs of all employees who 
complete a health risk assessment and participate in Employer C's 
wellness program. Employees do not have the right to receive cash or 
other taxable benefits in lieu of Employer C's non-elective 
contribution. The section 125 cafeteria plan nondiscrimination rules and 
not the comparability rules apply to Employer C's HSA contributions 
because the HSA contributions are made through the cafeteria plan.
    Example 4. Employer D's written cafeteria plan permits employees to 
elect to make pre-tax salary reduction contributions to their HSAs. 
Employees making this election have the right to receive cash or other 
taxable benefits in lieu of their HSA pre-tax contribution. Employees 
participating in the plan who are eligible individuals receive automatic 
employer contributions to their HSAs. Employees make no election with 
respect to Employer D's contribution and do not have the right to 
receive cash or other taxable benefits in lieu of Employer D's 
contribution but are permitted to make their own pre-tax salary 
reduction contributions to fund their HSAs. The section 125 cafeteria 
plan nondiscrimination rules and not the comparability rules apply to 
Employer D's HSA contributions because the HSA contributions are made 
through the cafeteria plan.

    Q-4: May all or part of the excise tax imposed under section 4980G 
be waived?
    A-4: In the case of a failure which is due to reasonable cause and 
not to willful neglect, all or a portion of the excise tax imposed under 
section 4980G may be waived to the extent that the payment of the tax 
would be excessive relative to the failure involved. See sections 
4980G(b) and 4980E(c).

[T.D. 9277, 71 FR 43058, July 31, 2006]



Sec. 54.4980G-6  Special rule for contributions made to the HSAs of 
nonhighly compensated employees.

    Q-1: May an employer make larger contributions to the HSAs of 
nonhighly compensated employees than to the HSAs of highly compensated 
employees?
    A-1: Yes. Employers may make larger HSA contributions for nonhighly 
compensated employees who are comparable participating employees than 
for highly compensated employees who are comparable participating 
employees. See Q & A-1 in Sec. 54.4980G-1 for the

[[Page 383]]

definition of comparable participating employee. For purposes of this 
section, highly compensated employee is defined under section 414(q). 
Nonhighly compensated employees are employees that are not highly 
compensated employees. The comparability rules continue to apply with 
respect to contributions to the HSAs of all nonhighly compensated 
employees. Employers must make comparable contributions for the calendar 
year to the HSA of each nonhighly compensated employee who is a 
comparable participating employee.
    Q-2: May an employer make larger contributions to the HSAs of highly 
compensated employees than to the HSAs of nonhighly compensated 
employees?
    A-2: (a) In general. No. Employer contributions to HSAs for highly 
compensated employees who are comparable participating employees may not 
be larger than employer HSA contributions for nonhighly compensated 
employees who are comparable participating employees. The comparability 
rules continue to apply with respect to contributions to the HSAs of all 
highly compensated employees. Employers must make comparable 
contributions for the calendar year to the HSA of each highly 
compensated comparable participating employee. See Q & A-1 in Sec. 
54.4980G-1 for the definition of comparable participating employee.
    (b) Examples. The following examples illustrate the rules in Q & A-1 
and Q & A-2 of this section. No contributions are made through a section 
125 cafeteria plan and none of the employees in the following examples 
are covered by a collective bargaining agreement. All of the employees 
in the following examples have the same HDHP deductible for the same 
category of coverage.

    Example 1. In 2010, Employer A contributes $1,000 for the calendar 
year to the HSA of each full-time nonhighly compensated employee who is 
an eligible individual with self-only HDHP coverage. Employer A makes no 
contribution to the HSA of any full-time highly compensated employee who 
is an eligible individual with self-only HDHP coverage. Employer A's HSA 
contributions for calendar year 2010 satisfy the comparability rules.
    Example 2. In 2010, Employer B contributes $2,000 for the calendar 
year to the HSA of each full-time nonhighly compensated employee who is 
an eligible individual with self-only HDHP coverage. Employer B also 
contributes $1,000 for the calendar year to the HSA of each full-time 
highly compensated employee who is an eligible individual with self-only 
HDHP coverage. Employer B's HSA contributions for calendar year 2010 
satisfy the comparability rules.
    Example 3. In 2010, Employer C contributes $1,000 for the calendar 
year to the HSA of each full-time nonhighly compensated employee who is 
an eligible individual with self-only HDHP coverage. Employer C 
contributes $2,000 for the calendar year to the HSA of each full-time 
highly compensated employee who is an eligible individual with self-only 
HDHP coverage. Employer C's HSA contributions for calendar year 2010 do 
not satisfy the comparability rules.
    Example 4. In 2010, Employer D contributes $1,000 for the calendar 
year to the HSA of each full-time nonhighly compensated employee who is 
an eligible individual with self-only HDHP coverage. Employer D also 
contributes $1,000 to the HSA of each full-time highly compensated 
employee who is an eligible individual with self-only HDHP coverage. In 
addition, the employer contributes an additional $500 to the HSA of each 
nonhighly compensated employee who participates in a wellness program. 
The nonhighly compensated employees did not receive comparable 
contributions, and, therefore, Employer D's HSA contributions for 
calendar year 2010 do not satisfy the comparability rules.
    Example 5. In 2010, Employer E contributes $1,000 for the calendar 
year to the HSA of each full-time non-management nonhighly compensated 
employee who is an eligible individual with family HDHP coverage. 
Employer E also contributes $500 for the calendar year to the HSA of 
each full-time management nonhighly compensated employee who is an 
eligible individual with family HDHP coverage. The nonhighly compensated 
employees did not receive comparable contributions, and, therefore, 
Employer E's HSA contributions for calendar year 2010 do not satisfy the 
comparability rules.

    Q-3: May an employer make larger HSA contributions for employees 
with self plus two HDHP coverage than employees with self plus one HDHP 
coverage even if the employees with self plus two are all highly 
compensated employees and the employees with self plus one are all 
nonhighly compensated employees?
    A-3: (a) Yes. Q & A-1 in Sec. 54.4980G-4 provides that an 
employer's contribution with respect to the self plus two category of 
HDHP coverage may not be

[[Page 384]]

less than the contribution with respect to the self plus one category 
and the contribution with respect to the self plus three or more 
category may not be less than the contribution with respect to the self 
plus two category. Therefore, the comparability rules are not violated 
if an employer makes a larger HSA contribution for the self plus two 
category of HDHP coverage than to self plus one coverage, even if the 
employees with self plus two coverage are all highly compensated 
employees and the employees with self plus one coverage are all 
nonhighly compensated employees. Likewise, the comparability rules are 
not violated if an employer makes a larger HSA contribution for the self 
plus three category of HDHP coverage than to self plus two coverage, 
even if the employees with self plus three coverage are all highly 
compensated employees and the employees with self plus two coverage are 
all nonhighly compensated employees.
    (b) Example. The following example illustrates the rules in 
paragraph (a) of this Q & A-3. In the following example, no 
contributions are made through a section 125 cafeteria plan and none of 
the employees are covered by a collective bargaining agreement.

    Example. In 2010, Employer F contributes $1,000 for the calendar 
year to the HSA of each full-time employee who is an eligible individual 
with self plus one HDHP coverage. Employer F contributes $1,500 for the 
calendar year to the HSA of each employee who is an eligible individual 
with self plus two HDHP coverage. The deductible for both the self plus 
one HDHP and the self plus two HDHP is $2,000. Employee A, an eligible 
individual, is a nonhighly compensated employee with self plus one 
coverage. Employee B, an eligible individual, is a highly compensated 
employee with self plus two coverage. For the 2010 calendar year, 
Employer F contributes $1,000 to Employee A's HSA and $1,500 to Employee 
B's HSA. Employer F's HSA contributions satisfy the comparability rules.

    Q-4:What is the effective date for the rules in this section?
    A-4: The rules in this section are effective for employer 
contributions made for calendar years beginning on or after January 1, 
2010.

[T.D. 9457, 74 FR 45998, Sept. 8, 2009]



Sec. 54.4980G-7  Special comparability rules for qualified HSA 
distributions contributed to HSAs on or after December 20, 2006 and 

before January 1, 2012.

    Q-1 How do the comparability rules of section 4980G apply to 
qualified HSA distributions under section 106(e)(2)?
    A-1:The comparability rules of section 4980G do not apply to amounts 
contributed to employee HSAs through qualified HSA distributions. 
However, in order to satisfy the comparability rules, if an employer 
offers qualified HSA distributions, as defined in section 106(e)(2), to 
any employee who is an eligible individual covered under any HDHP, the 
employer must offer qualified HSA distributions to all employees who are 
eligible individuals covered under any HDHP. However, if an employer 
offers qualified HSA distributions only to employees who are eligible 
individuals covered under the employer's HDHP, the employer is not 
required to offer qualified HSA distributions to employees who are 
eligible individuals but are not covered under the employer's HDHP.
    Q-2: What is the effective date for the rules in this section?
    A-2: The rules in this section are effective for are effective for 
employer contributions made for calendar years beginning on or after 
January 1, 2010.

[T.D. 9457, 74 FR 45999, Sept. 8, 2009]



Sec. 54.4981A-1T  Tax on excess distributions and excess accumulations 
(temporary).

    The following questions and answers relate to the tax on excess 
distributions and excess accumulations under section 4981A of the 
Internal Revenue Code of 1986, as added by section 1133 of the Tax 
Reform Act of 1986 (Pub. L. 99-514) (TRA '86).

                            Table of Contents

a. General Provisions and Excess Distributions
b. Special Grandfather Rules
c. Special Rules
d. Excess Accumulations

             a. General Provisions and Excess Distributions

    a-1: Q. What changes were made by section 1133 of TRA '86 regarding 
excise

[[Page 385]]

taxes applicable to distributions from qualified employer plans and 
individual retirement plans?
    A. Section 1133 of TRA '86 added section 4981A to the Code. Section 
4981A imposes an excise tax of 15 percent on (a) excess distributions, 
as defined in section 4981A(c)(1) and Q&A a-2 of this section, and (b) 
excess accumulations, as defined in section 4981A(d)(3) and Q&A d-2 of 
this section. The excise tax on excess distributions generally applies 
to excess distributions made after December 31, 1986 (see Q&A c-6 of 
this section). The excise tax on excess accumulations applies to estates 
of decedents dying after December 31, 1986 (see Q&A d-11 of this 
section). Excess distributions are certain distributions from qualified 
employer plans and individual retirement plans. Excess accumulations are 
certain amounts held on the date of death of an employee or individual 
by qualified plans and individual retirement plans.
    a-2: Q. How are excess distributions defined?
    A. Excess distributions are generally defined as the excess of the 
aggregate amount of distributions received by or with respect to an 
individual during a calendar year over the greater of (a) $150,000 
(unindexed) or (b) $112,500 (indexed as provided in Q&A a-9 of this 
section beginning in 1988 for cost-of-living increases). Certain 
individuals may elect to have the portion of their excess distributions 
that is subject to tax determined under a ``special grandfather'' rule 
that is described below (see Q&A b-1 through b-14 of this section).
    a-3: Q. Distributions from what plans and arrangements are taken 
into account in applying section 4981A?
    A. (a) General rule. Section 4981A applies to distributions under 
any qualified employer plan or individual retirement plan described in 
section 4981A(e). For this purpose, a qualified employer plan means 
any--
    (1) Qualified pension, profit-sharing or stock bonus plan described 
in section 401(a) that includes a trust exempt from tax under section 
501(a);
    (2) Annuity plan described in section 403(a);
    (3) Annuity contract, custodial account, or retirement income 
account described in section 403(b)(1), 403(b)(7) or 403(b)(9); and
    (4) Qualified bond purchase plan described in section 405(a) prior 
to that section's repeal by section 491(a) of the Tax Reform Act of 1984 
(TRA '84).
    (b) Individual retirement plan. An individual retirement plan is 
defined in section 7701(a)(37) and means any individual retirement 
account described in section 408(a) or individual retirement annuity 
described in section 408(b). Also, an individual retirement plan 
includes a retirement bond described in section 409(a) prior to that 
section's repeal by section 491(b) of the Tax Reform Act of 1984 (TRA 
'84).
    (c) Other distributions. (1) Distributions under any plan, contract 
or account that has at any time been treated as a qualified employer 
plan or individual retirement plan described in paragraph (a) or (b) of 
this Q&A a-3 will be treated for purposes of section 4981A as 
distributions from a qualified employer plan or individual retirement 
plan whether or not such plan, contract, or account satisfies the 
applicable qualification requirements at the time of the distribution.
    (2)(i) For purposes of this paragraph (c), an employer plan will be 
considered to have been treated as a qualified employer plan if any 
employer maintaining the plan has at any time filed an income tax return 
and claimed deductions that would be allowable under section 404 (and 
that were not disallowed) only if the plan was a qualified employer plan 
under section 401(a) or 403(a). Similarly, if an income tax return has 
been filed at any time with respect to the trust (or plan or insurance 
company), and the income of the trust (insurance company, etc.) is 
reported (and is not disallowed) based on the trust (or plan) being 
treated as a qualified employer plan described in section 401(a), or 403 
(a) or (b), then the employer plan is considered to have been treated as 
a qualified employer plan.
    (ii) For purposes of this paragraph (c), an individual retirement 
plan (IRA) will be considered to have been treated as a qualified IRA if 
any contributions to the IRA were either deducted (or designated as a 
nondeductible contribution described in section 408(o)) on

[[Page 386]]

a filed individual income tax return or excluded from an individual's 
gross income on a filed income tax return because such contributions 
were reported as regular contributions or rollover contributions (such 
as those described in section 402(a)(5), 403(a)(4), 403(b)(8) or 
408(d)(3)) to an IRA described in section 408 (a) or (b) (or section 409 
of pre-1984 law). Similar treatment applies to an employer contribution 
to a simplified employee pension described in section 408(k), if such 
contribution is deducted on an employer's filed income tax return, 
including a self-employed individual's return.
    a-4: Q. Which distributions with respect to an individual under a 
qualified employer plan or an individual retirement plan are excluded 
from consideration for purposes of determining an individual's excess 
distributions?
    A. (a) Exclusions. In determining the extent to which an individual 
has excess distributions for a calendar year, the following 
distributions are disregarded--
    (1) Any distribution received by any person with respect to an 
individual as a result of the death of that individual.
    (2) Any distribution with respect to an individual that is received 
by an alternate payee under a qualified domestic relations order within 
the meaning of section 414(p) that is includible in the income of the 
alternate payee.
    (3) Any distribution with respect to an individual that is 
attributable to the individual's investment in the contract as 
determined under the rules of section 72(f). This would include, for 
example, distributions that are excluded from gross income under section 
72 because they are treated as a recovery of after-tax employee 
contributions from a qualified employer plan or nondeductible 
contributions from an individual retirement plan.
    (4) Any portion of a distribution to the extent that it is not 
included in gross income by reason of a rollover contribution described 
in section 402(a)(5), 403(a)(4), 403(b)(8), or 408(d)(3).
    (5) Any health coverage or any distribution of medical benefits 
provided under an arrangement described in section 401(h) to the extent 
that the coverage or distribution is excludible under section 104, 105, 
or 106.
    (b) Alternate payee. Any distributions to an alternate payee 
described in paragraph (a)(2) of this Q&A a-4 must be taken into account 
by such alternate payee for purposes of calculating the excess 
distributions received by (or excess accumulations held by) the 
alternate payee.
    a-5: Q. If an annuity contract that represents an irrevocable 
commitment to provide an employee's benefits under the plan is 
distributed to an individual, how are the distribution of such annuity 
contract and distributions of amounts under such a contract taken into 
account for purposes of calculating excess distributions?
    A. Except to the extent that the value of an annuity contract is 
includible in income in the year the contract is distributed or any 
subsequent year, the distribution of an annuity contract (including a 
group annuity contract) in satisfaction of plan liabilities is 
disregarded for purposes of calculating excess distributions. Any 
amounts that are actually distributed under the contract to the 
individual (to the extent not excluded under Q&A a-4 of this section) or 
are otherwise includible in income with respect to the contract (e.g., 
by reason of the inclusion in income of the value of the annuity 
contract in the year of the contract's distribution or any subsequent 
year) are taken into account for purposes of calculating excess 
distributions for the calendar year during which such amounts are 
received or otherwise includible in income. For purposes of this Q&A a-
5, the term plan means any qualified employer plan or individual 
retirement plan specified in section 4981A(e) and Q&A a-3 of this 
section.
    a-6: Q. Are minimum distributions required under section 401(a)(9), 
408(a)(6), 408(b)(3) or 403(b)(10) taken into account to determine 
excess distributions?
    A. Yes. Distributions received during a calendar year are taken into 
account in determining an individual's excess distributions for such 
calendar year even though such distributions are required under section 
401(a)(9), 408(a)(6), 408(b)(3) or 403(b)(10). For example, minimum 
distributions under section 401(a)(9) received during the 1987 calendar 
year for calendar years 1985 and

[[Page 387]]

1986 will be subject to section 4981A as distributions for 1987.
    a-7: Q. Are distributions of excess deferrals permitted under 
section 402(g)(2), or distributions of excess contributions or excess 
aggregate contributions permitted under section 401(k) or (m), or 
distributions of IRA contributions permitted under section 408(d) (4) or 
(5) taken into account for purposes of calculating excess distributions?
    A. No. Distributions of excess deferrals, excess contributions, 
excess aggregate contributions, distributions of IRA contributions, and 
income allocable to such contributions or deferrals, that are made in 
accordance with the provisions of sections 402(g)(2), 401(k)(8), 
401(m)(6), or 408(d) (4) or (5) are not taken into account for purposes 
of calculating excess distributions.
    a-8: Q. What distributions from qualified employer plans or 
individual retirement plans are taken into account in determining an 
individual's excess distributions?
    A. With the exception of distributions noted above in Q&As a-4, a-5, 
and a-7 of this section, all distributions from qualified employer plans 
or individual retirement plans must be taken into account in determining 
an individual's excess distributions for the calendar year in which such 
distributions are received. In general, all such distributions are taken 
into account whether or not they are currently includible in income. 
Thus, for example, net unrealized appreciation in employer securities 
described in section 402(a) is taken into account in the year 
distributed. However, health coverage or distributions of medical 
benefits provided under an arrangement described in section 401(h) that 
are excludible from income under section 104, 105, or 106 are not 
subject to section 4981A. In addition, distributions that are excludible 
from income because they are rolled over to a plan or an individual 
retirement account are not taken into account. (See Q&A a-4(a) (4) and 
(5) of this section). Amounts that are includible in income for a 
calendar year are treated as distributions and, thus, are taken into 
account even if the amounts are not actually distributed during such 
year. Thus, deemed distributions to provide insurance coverage 
includible in income under section 72 (PS-58 amounts), loan amounts 
treated as deemed distributions under section 72(p), and amounts 
includible under section 402(b) or section 403(c) by reason of the 
employer plan or individual retirement plan not being qualified during 
the year are taken into account.
    a-9: Q. Will the dollar threshold amount used to determine an 
individual's excess distributions be adjusted for inflation in calendar 
years after 1987?
    A. Beginning in 1988, the $112,500 threshold amount is adjusted to 
reflect post-1986 cost-of-living increases (COLAs) at the same time and 
in the same manner as the adjustment described in section 415(d). The 
threshold amount is adjusted even though the distribution is from a 
defined contribution plan that is subject to a freeze on COLAs because 
the defined benefit plan limit is below $120,000 (see section 
415(c)(1)(A)). However, the $150,000 threshold amount is not adjusted to 
reflect such increases.

                       b. Special Grandfather Rule

    b-1: Q. How are benefits accrued before TRA '86 treated under the 
excise tax provisions described in section 4981A?
    A. (a) Grandfather amount. Certain eligible individuals may elect to 
use a special grandfather rule that exempts from the excise tax the 
portion of distributions treated as a recovery of such individual's 
total benefits accrued on or before August 1, 1986 (grandfather amount). 
However, distributions that are treated as a recovery of the grandfather 
amount are taken into account in determining the extent to which other 
distributions are excess distributions (see Q&A b-4 of this section). 
Under this special grandfather rule, the grandfather amount equals the 
value of an individual's total benefits (as described in Q&As b-8 and b-
9 of this section) in all qualified employer plans and individual 
retirement plans on August 1, 1986. An individual's benefits in such 
plans include amounts determinable on August 1, 1986, that are payable 
to the individual under a qualified domestic relations order within

[[Page 388]]

the meaning of section 414(p) (QDRO). However, QDRO benefits that, when 
destributed, are includible in the income of the alternate payee are not 
included in the employee's grandfathered amount. Further, plan benefits 
that are attributable to a deceased individual and that are payable to 
an eligible individual as a beneficiary are generally not included in 
determining the eligible individual's grandfather amount. Procedures for 
determining the grandfather amount are described in Q&As b-11 through b-
14 of this section.
    (b) Recovery of grandfather amount. The portion of any distribution 
made after August 1, 1986, that is treated as a recovery of a 
grandfather amount depends on which of two grandfather recovery methods 
the individual elects. The two alternative methods are described in the 
Q&As b-11 through b-14 of this section. The amount of the distribution 
for a year that is treated as a recovery of a grandfather amount in a 
year is applied to reduce the individual's unrecovered grandfather 
amount for future years (i.e., the individual's accrued benefits as 
described in Q&As b-8 and b-9 on August 1, 1986, reduced by previous 
distributions treated as a recovery of a grandfather amount) on a dollar 
for dollar basis until the individual's unrecovered grandfather amount 
has been reduced to zero. When the individual's grandfather amount has 
been reduced to zero, the special grandfather rule ceases to apply and 
the entire amount of any subsequent excess distributions received is 
subject to the 15 percent excise tax.
    b-2: Q. Who may elect to use the special grandfather rules?
    A. Any individual whose accrued benefits as described in Q&As b-8 
and b-9 of this section in all qualified plans and individual retirement 
plans on August 1, 1986 (initial grandfather amount) have a value of at 
least $562,500 may elect to use the special grandfather rule.
    b-3: Q. How does an eligible individual make a valid election to use 
the special grandfather rule?
    A. (a) Form of election. An individual who is eligible to use the 
special grandfather rule must affirmatively elect to use that rule. The 
election is made on a Form 5329 filed with the individual's income tax 
return (Form 1040, etc.) for a taxable year beginning after December 31, 
1986, and before January 1, 1989 (i.e., the 1987 or 1988 taxable year).
    (b) Information required. The individual must report the following 
information on the Form 5329:
    (1) The individual's initial grandfather amount.
    (2) The grandfather recovery method to be used.
    (3) Such other information as is required by the Form 5329.
    (c) Deadline for election. The deadline for filing such election is 
the due date, calculated with extensions, for filing the individual's 
1988 income tax return. If an individual dies before the expiration of 
such deadline, an election, or the revocation of a prior election, may 
be made as part of the final income tax return filed on behalf of such 
deceased individual by the deceased individual's personal 
representative. An election or revocation of a prior election may also 
be filed before the expiration of such deadline with Schedule S (Form 
706). See Q&A c-7 of this section.
    (d) Revocation of election. Elections filed before the deadline may 
be revoked by filing an amended income tax return for any applicable 
year. A change in the grandfather recovery method is considered a 
revocation of a prior election and an amended Form 5329 must be filed 
for any prior year in which a different grandfather recovery method was 
used. Thus, a change in the election may require a change in the 1987 
tax return. An individual must refile for 1987 based on the new election 
if additional tax is owed. However, an election (or nonelection) is 
irrevocable after the filing deadline for the taxable year beginning in 
1988 has passed. Thus, an individual who has not made an election by the 
last day plus extensions for filing the 1988 return may not do so 
through an amended return.
    (e) Subsequent years. (1) Any eligible individual who has elected 
the special grandfather rule must attach to the individual's income tax 
return for all subsequent taxable years in which the individual receives 
excess distributions (determined without regard to the grandfather rule) 
a copy of the Form 5329 on which the individual elected the

[[Page 389]]

grandfather rule. A copy of the Form 5329 on which the individual (or 
the individual's personal representative) elected the grandfather rule 
must also be filed with Schedule S (Form 706) unless the initial 
election is filed with such schedule.
    (2) The individual must also make such other reports in the form and 
at the time as the Commissioner may prescribe. See Q&A c-7 of this 
section for the applicable reporting requirements if the individual or 
the individual's estate is liable for any tax on excess distributions or 
on an excess accumulation under section 4981A (a) or (d).
    b-4: Q. How individuals who have elected to use the special 
grandfather rule determine the extent to which their distributions for 
any calendar year are excess distributions?
    A. (a) Excess distributions under grandfather rule, threshold 
amount. Individuals who elect to use the special grandfather rule are 
not eligible to use the $150,000 threshold amount in computing their 
excess distributions for any calendar year. Instead, such electing 
individuals must compute their excess distributions for a calendar year 
using a $112,500 (indexed for cost-of-living increases) threshold 
amount. The rule of this paragraph (a) applies for all calendar years, 
including the calendar year in which an individual's unrecovered 
grandfather amount has been reduced to zero and all subsequent calendar 
years. Once the indexed amount has increased to $150,000 or more, the 
threshold amount will be the same for all individuals.
    (b) Base for excise tax under grandfather rule. Although the portion 
of any distribution that is treated as a recovery of an individual's 
grandfather amount is not subject to the excise tax, such portion must 
be taken into account in determining the extent to which the individual 
has excess distributions for a calendar year. The effect of this rule is 
that the amount against which the 15 percent excise tax is applied for 
any calendar year during which a grandfather amount is recovered equals 
the individual's distributions for such year reduced by the greater of 
(1) the applicable threshold amount for such year or (2) the grandfather 
amount recovered for such year. (See the examples in Q&A b-14 of this 
section.)
    b-5: Q. How is the value of an individual's total accrued benefits 
on August 1, 1986, calculated for purposes of determining (a) whether an 
individual is eligible to elect the special grandfather rule and (b) the 
amount of any electing individual's initial grandfather amount under 
such rule?
    A. (a) Introduction. The value of an individual's total accrued 
benefits on August 1, 1986, is the sum of the values of the individual's 
accrued benefits on such date under all qualified employer plans or 
individual retirement plans, as determined under the Q&A b-5. If such 
value exceeds $562,500, the individual may elect the special grandfather 
rule. In such case, the value so determined may be applied against 
distributions as determined under this section, whether or not such 
distributions are from the same plan or IRA for which such grandfather 
amount is determined. For purposes of determining the value of accrued 
benefits on August 1, 1986, an annuity contract or an individual's 
interest in a group annuity contract described in Q&A a-5 of this 
section is treated as an accrued benefit under the qualified retirement 
plan or IRA from which it was distributed and an IRA is treated as a 
defined contribution plan.
    (b) Defined benefit plan--(1) General rule. The amount of an 
individual's accrued benefit on August 1, 1986, under a defined benefit 
plan is determined as of that date under the provisions of the plan 
based on the individual's service and compensation on that date. The 
present value of such benefit is determined by an actuarial valuation of 
such accrued benefit performed as of August 1, 1986. Alternatively, 
accrued benefits may be determined as of July 31, 1986. In such case, 
the applicable rules are applied by substituting the July 31 date for 
the August 1 date in the applicable provisions. (See Q&A b-9 of this 
section for rules for determining the amount of benefits and values and 
the actuarial assumptions to be used in such determination.)
    (2) Alternative method. Alternatively, the present value of an 
individual's accrued benefit on August 1, 1986, may be determined using 
the following method:

[[Page 390]]

    (i) Determine the amount of the individual's actual accrued benefit 
(prior benefit) on the valuation date that immediately precedes August 
1, 1986 (prior date). The valuation date for purposes of using this 
alternative method is the valuation date used for purposes of section 
412. In making this determination, plan amendments that are adopted 
after that prior date are disregarded.
    (ii) Determine the amount of the individual's adjusted accrued 
benefit (adjusted prior benefit) on the prior date by reducing the prior 
benefit in paragraph (b)(2)(i) of this Q&A b-5 by the amount of 
distributions that reduce the accrued benefit or transfers from the plan 
and by increasing the prior benefit in paragraph (b)(2)(i) of this Q&A 
b-5 by any increase in benefit resulting from either transfers to the 
plan or plan amendments that were made (or, in the case of a plan 
amendment, both adopted and effective) after the prior valuation date, 
but on or before August 1, 1986.
    (iii) Determine the amount of the individual's actual accrued 
benefit (future benefit) on the valuation date immediately following 
August 1, 1986 (next date). In making this determination, plan 
amendments, etc. that are either adopted or effective after August 1 are 
disregarded.
    (iv) Determine the amount of the individual's adjusted accrued 
benefit (adjusted future benefit) on the next date by increasing the 
future benefit in paragraph (b)(2)(iii) of this Q&A b-5 by the amount of 
any distributions that reduce the accrued benefit or transfers from the 
plan and by reducing the future benefit in paragraph (b)(2)(iii) of this 
Q&A b-5 by the amount of any transfer to the plan that was made after 
August 1, 1986, but on or before the next valuation date to the amount 
in paragraph (b)(2)(iii) of this Q&A b-5.
    (v) Calculate the weighted average of paragraphs (b)(2)(ii) and 
(b)(2)(iv) of this Q&A b-5, where the weights applied are the number of 
complete calendar months separating the applicable prior date and the 
applicable next date, respectively, and August 1, 1986.
    (vi) Determine the actuarial present value of the benefit in 
paragraph (b)(2)(v) of this Q&A b-5 as of August 1, 1986, using the 
methods and assumptions described in Q&A b-9 of this section.
    The grandfather amount on August 1, 1986, attributable to the 
accrued benefits under the defined benefit plan is equal to the amount 
determined in paragraph (b)(2)(vi) of this Q&A b-5.
    (3) Certain insurance plans treated as defined contribution plans. 
(i) Accrued benefits not in pay status under a plan satisfying the 
requirements of section 411(b)(1)(F) are determined under the rules in 
paragraph (c) of this Q&A b-5 for defined contribution plans. For 
purposes of applying paragraph (c) of this Q&A b-5 to such benefits, the 
cash surrender value of the contract is substituted for the account 
balance. If accrued benefits are in pay status under such a plan, the 
rules of this paragraph (b) apply to such benefits.
    (ii) Accrued benefits not in pay status that are attributable to 
voluntary employee contributions (including rollover amounts) to a 
defined benefit plan are determined under the rules in paragraph (c) of 
this Q&A b-5 as if the account balance attributable thereto is under a 
defined contribution plan. If such benefits are in pay status and are 
used to fund the benefit under the defined plan, the rules of this 
paragraph (b) apply to such benefits.
    (c) Defined contribution plan--(1) General rule. The value of an 
individual's accrued benefit on August 1, 1986, under a defined 
contribution plan (including IRAs) is the value of the individual's 
account balance on such date (or on the immediately preceding day). 
Paragraph (b)(3) of this Q&A b-5 requires that benefits derived from 
certain insured plans and from voluntary contributions to a defined 
benefit plan be determined under the rules of this paragraph (c).
    (2) Alternative method. Alternatively, if a valuation was not 
performed as of August 1, 1986 (or as of the immediately preceding day), 
the value of an individual's accrued benefit may be determined as 
follows:
    (i) Determine the value of the individual's account balance on the 
valuation date immediately preceding August 1, 1986 (prior valuation 
date).
    (ii) Determine the value of the individual's adjusted account 
balance on

[[Page 391]]

the prior valuation date by subtracting (or adding, respectively) the 
amount of any distribution, including a transfer to another plan or a 
forfeiture from the account balance (or the amount of any allocation to 
the account balance, including a transfer from another plan, rollover 
received or forfeiture from another account) that was made after the 
prior valuation date but on or before August 1, 1986, from (or to) the 
amount in paragraph (c)(2)(i) of this Q&A b-5.
    (iii) Determine the value of the individual's account balance on the 
valuation date immediately following August 1, 1986 (next valuation 
date).
    (iv) Determine the value of the individual's adjusted account 
balance on the next valuation date by adding (or subtracting, 
respectively) the amount of any distribution, of a type described in 
paragraph (c)(2)(ii) of this Q&A b-5 (or the amount of any allocation to 
the account balance, of a type described in paragraph (c)(2)(ii) of this 
Q&A b-5), that was made after August 1, 1986, but on or before the next 
valuation date to (or from) the amount in paragraph (c)(2)(iii) of this 
Q&A b-5.
    (v) Calculate the weighted average of paragraphs (c)(2)(ii) and 
(c)(2)(iv) of this Q&A b-5, where the weights applied are the number of 
complete calendar months separating the applicable valuation date and 
the applicable next date, respectively, and August 1, 1986.
    The grandfather amount on August 1, 1986, attributable to the 
account balance in the defined contribution plan or the individual 
retirement plan is the amount in paragraph (c)(2)(v) of this Q&A b-5.
    b-6: Q. For purposes of determining the value of accrued benefits in 
a defined contribution plan or a defined benefit plan on August 1, 1986, 
are nonvested benefits taken into account?
    A. Yes. All accrued benefits, whether or not vested, are taken into 
account.
    b-7: Q. To what extent are benefits payable with respect to an 
individual under a qualified employer plan or an individual retirement 
plan not taken into account for purposes of calculating the individual's 
grandfather amount?
    A. (a) Exclusions. The following benefits payable with respect to an 
individual are not taken into account for purposes of this calculation:
    (1) Benefits attributable to investment in the contract as defined 
in section 72(f). However, amounts attributable to deductible employee 
contributions (as defined in section 72(o)(5)(A)) are considered part of 
the accrued benefit.
    (2) Amounts that are determinable on August 1, 1986, as payable to 
an alternate payee who is required to include such amounts in gross 
income (a spouse or former spouse) under a qualified domestic relations 
order (QDRO) within the meaning of section 414(p).
    (3) Amounts that are attributable to IRA contributions that are 
distributed pursuant to section 408(d) (4) or (5).
    (b) Alternate payee. Under a QDRO described in paragraph (a)(2) of 
this Q&A b-7, amounts are considered part of the accrued benefit of the 
alternate payee for purposes of calculating the value of the alternate 
payee's accrued benefit on August 1, 1986. Similarly, such amounts are 
used by the alternate payee to compute excess distributions.
    b-8: Q. What adjustments to the grandfather amount are necessary to 
take into account rollovers from one qualified employer plan or 
individual retirement plan to another such plan?
    A. (a) Rollovers outstanding on valuation date. Generally, rollovers 
between plans result in adjustment to the grandfather amounts under the 
rules in Q&A b-5 of this section. However, if a rollover amount is 
distributed from one plan on or before an applicable valuation date of 
such plan and is rolled over into the receiving plan after the receiving 
plan's applicable valuation date and if these events result in an 
inappropriate duplication or omission of the rollover amount, then an 
adjustment to the grandfather amount must be made to remove the 
duplication or omission. The Commissioner may provide necessary rules 
concerning this adjustment.
    (b) Valuation. If the rollover amount described in paragraph (a) of 
this Q&A b-8 is in a form of property other than cash, the property of 
which the outstanding rollover consists is valued as of the date the 
rollover contribution is received by the transferee qualified employer 
plan or individual retirement

[[Page 392]]

plan and that value is the amount of the rollover. If the outstanding 
rollover is in the form of cash, the amount of the cash is the amount of 
the rollover.
    b-9: Q. What is the form of the grandfather benefit under a defined 
benefit plan and how is it valued?
    A. (a) Benefit form. The grandfather amount under a defined benefit 
plan is determined on the basis of the form of benefit (including any 
subsidized form of benefit such as a subsidized early retirement benefit 
or a subsidized joint and survivor annunity) provided under the plan as 
of August 1, 1986 that has the greatest present value as determined in 
paragraph (b) of this b-9. If the plan provides a subsidized joint and 
survivor annunity, for purposes of determining the grandfather amount, 
it will be assumed that an unmarried individual is married and that the 
individual spouse is the same age as the individual. Assumptions as to 
future withdrawals, future salary increases or future cost-of-living 
increases are not permitted.
    (b) Value of grandfather amount. The grandfather amount under a 
defined benefit plan is the present value of the individual's benefit 
form determined under paragraph (a) of this Q&A b-9. Thus, the benefit 
form is reduced to reflect its value on the applicable valuation date. 
The present value of the benefit form on August 1, 1986, or the 
applicable date, is computed using the factors specified under the terms 
of the plan as in effect on August 1, 1986, to calculate a single sum 
distribution if the plan provides for such a distribution. If the plan 
does not provide for such a distribution form, such present value is 
computed using the interest rate and mortality assumptions specified in 
Sec. 20.2031-7 of the Estate Tax Regulations.
    b-10: Q. Is the plan administrator (or trustee) of a qualified plan 
(or individual retirement account) required to report to an individual 
the value of the individual's benefit under the plan as of August 1, 
1986?
    A. (a) Request required. No report is required unless the individual 
requests a report and the request is received before April 15, 1989. If 
requested, the plan administrator (or trustee or issuer) must report to 
such individual the value of the individual's benefit under the plan as 
of August 1, 1986, determined in accordance with Q&A b-5 through b-9 of 
this section. Such report must be made within a reasonable time after 
the individual's request but not later than July 15, 1989.
    (b) Other rules. Alternate payees must make their own request for 
valuation reports. Any report furnished to an employee who has an 
alternate payee with respect to the plan must include the separate 
values attributable to each such individual. Any report furnished to an 
alternate payee must include only the value attributable to the 
alternate payee. Reports may be furnished to individuals even if no 
request is made. Individuals must keep records of the reports received 
from plans or IRAs in order to substantiate all grandfather amounts.
    (c) Authority. The rules in this Q&A are provided under the 
authority in section 6047(d).
    b-11: Q. How is the portion of a distribution that is treated as a 
recovery of an individual's grandfather amount as described in b-1 of 
this section to be calculated?
    A. (a) General rule. All distributions received between August 1 and 
December 31, 1986, inclusive, are treated as a recovery of a grandfather 
amount. The portion of distributions received after December 31, 1986, 
that is treated as a recovery of the grandfather amount is determined 
under either the discretionary method or the attained age method. An 
amount that is treated as a recovery of grandfather benefits is applied 
to reduce the initial grandfather amount that was calculated as of 
August 1, 1986, on a dollar for dollar basis until the unrecovered 
amount has been reduced to zero. No other recalculation of the 
grandfather amount is to be made for a date after August 1, 1986.
    (b) Methods, etc. The grandfather amount may be recovered by an 
individual under either the discretionary method or the attained age 
method. After the individual's total grandfather amount is treated as 
recovered under either method, the tax on excess distributions and 
excess accumulations is determined without regard to any grandfather 
amount.

[[Page 393]]

    b-12: Q. Under the discretionary method, what portion of each 
distribution is treated as a return of the individual's grandfather 
amount?
    A. (a) Initial percentage. Under the discretionary method, unless 
the individual elects in accordance with paragraph (b) below, 10 percent 
of the total distributions that the individual receives during any 
calendar year is treated as a recovery of the grandfather amount.
    (b) Acceleration. The individual may elect to accelerate the rate of 
recovery to 100 percent of the total aggregate distributions received 
during a calendar year commencing with any calendar year, including 1987 
(acceleration election). In such case, the rate of recovery is 
accelerated to 100 percent for the calendar year with respect to which 
the election is made and for all subsequent calendar years.
    (c) Election. To recover the grandfather amount using the 
discretionary method, an individual must elect to use such method when 
making the election to use the special grandfather rule on the Form 
5329. (See Q&A b-3 of this section.) The acceleration election must be 
made for the individual's taxable year beginning with or within the 
first calendar year for which such election is made and must be filed 
with the individual's income tax return for that year. Such acceleration 
election may also be made or revoked retroactively on an amended return 
for such year. However, the acceleration election may not be made after 
the individual's death other than with the individual's final income tax 
return or with a return for a prior year for which a return was not 
filed before the individual's death. Thus, the acceleration election may 
not be made on an amended return filed after the individual's death for 
a year for which a return was filed before the individual's death. The 
preceding two sentences shall not apply to deaths occurring in 1987 or 
1988. The estate is entitled to use the remaining grandfather amount to 
determine if there is an excess accumulation. See Q&A d-3 of this 
section. The acceleration election shall be made on such form and in 
such manner as the Commissioner prescribes in a manner consistent with 
the rules of this section.
    b-13: Q. Under the attained age method, what portion of each 
distribution is treated as a return of the individual's grandfather 
amount?
    A. Under the attained age method, the portion of total distributions 
received during any year that is treated as a recovery of an 
individual's grandfather amount is calculated by multiplying the 
individual's aggregate distributions for a calendar year by a fraction. 
The numerator of the fraction is the difference between the individual's 
attained age in completed months on August 1, 1986, and the individual's 
attained age in months at age 35 (420 months). The denominator of the 
fraction is the difference between the individual's attained age in 
completed months on December 31 of the calendar year and the 
individual's attained age in months at age 35 (420 months). An 
individual whose 35th birthday is after August 1, 1986, may not use the 
attained age method.
    b-14: Q. How is the 15 percent tax with respect to excess 
distributions for a calendar year calculated by an individual who has 
elected to use the special grandfather rule?
    A. The calculation of the excise tax may be illustrated by the 
following examples:

    Example 1. (a) An individual (A) who participates in two retirement 
plans, a qualified defined contribution plan and a qualified defined 
benefit plan, has a total value of accrued benefits on August 1, 1986 
under both plans of $1,000,000. Because this amount exceeds $562,500, A 
is eligible to elect to use the special grandfather rule to calculate 
the portion of subsequent distributions that are exempt from tax. A 
elects to use the discretionary grandfather recovery method and attaches 
a valid election to the 1987 income tax return. A does not elect to 
accelerate the rate of recovery for 1987. On October 1, 1986, A receives 
a distribution of $200,000. On February 1, 1987, A receives a 
distribution of $45,000 and, on November 1, 1987, receives a 
distribution of $200,000. The 15 percent excise tax applicable to 
aggregate distributions in 1987 is calculated as follows:

(1) Value of grandfather amount on 8/1/86.....................$1,000,000
(2) Grandfather amounts recovered in 1986 but after 8/1/86......$200,000
(3) Value of grandfather amount on 12/31/86 ((1)-(2))...........$800,000
(4) Grandfather recovery percentage..................................10%
(5) Distributions between 1/1/87 and 12/

[[Page 394]]

31/87 ($45,000x$200,000)........................................$245,000
(6) Portion of (5) exempt from tax ((4)x(5)).....................$24,500
(7) Amount potentially subject to tax ((5)-(6)).................$220,500
(8) Portion of aggregate distributions in excess of $112,500 
($45,000x$200,000-$112,500).....................................$132,500
(9) Amount subject to tax (lesser of (7) and (8))...............$132,500
(10) Amount of tax (15% of (9))..................................$19,875
(11) Remaining undistributed value of grandfather amount as of 12/31/87 
((3)-(6)).......................................................$775,500

    (b) In 1988, A receives no distributions from either plan. On 
February 1, 1989, A receives a distribution of $300,000 and on December 
31, 1989, receives a distribution of $75,000. A makes a valid 
acceleration election for the 1989 taxable year, whereby A accelerates 
the rate of grandfather recovery that will apply for calendar years 
after 1988 to 100 percent. Assume the annual threshold amount for the 
1989 calendar year is $125,000 (i.e., 112,500 indexed). The 15 percent 
excess tax applicable to distributions in 1989 is calculated as follows:

(1) Value of grandfather amount on 8/1/86.......................$775,500
(2) Grandfather recovery percentage designated for 1989 calendar year 
                                                                    100%
(3) Distributions between 1/1/89 and 12/31/89 ($300,000x$75,000) 
                                                                $375,000
(4) Portion of (3) exempt from tax (2)x(3)......................$375,000
(5) Amount potentially subject to tax ((3)-(4)).......................$0
(6) Portion of aggregate distributions in excess of $125,000 
($300,000x$75,000-$125,000).....................................$250,000
(7) Amount subject to tax (lesser of (5) and (6)).....................$0
(8) Amount of tax (15% of (7))........................................$0
(9) Remaining undistributed value of grandfather amount as of 12/31/89 
((1)-(4)).......................................................$400,500

    The entire amount of any distribution for subsequent calendar years 
will be treated as a recovery of the grandfather amount and applied 
against the grandfather amount until the unrecovered grandfather amount 
is reduced to zero.
    Example 2. The facts are the same as in Example 1 except that A 
elects to use the attained age recovery method and A makes a valid 
election for the 1987 taxable year. Further assume that A's attained age 
in months on August 1, 1986 is 471 months and on December 31, 1987, is 
488 months. The 15 percent excise tax applicable to aggregate 
distributions in 1987 is calculated as follows:

(1) Value of grandfather amount on 8/1/86.....................$1,000,000
(2) Grandfather amounts recovered in 1986 but after 8/1/86......$200,000
(3) Value of grandfather amount on 12/31/86 ((1) - (2)).........$800,000
(4) Completed months of age in excess of 420 on 8/1/86................51
(5) Completed months of age in excess of 420 on 12/31/87..............68
(6) Grandfather fraction as of 12/31/86 ((4) divided by (5)).......\3/4\
(7) Distributions between 1/1/87 and 12/31/87 ($45,000 + $200,000) 
                                                                $245,000
(8) Portion of (7) exempt from tax ((6)x(7))....................$183,750
(9) Amount potentially subject to tax ((7)-(8))..................$61,250
(10) Portion of aggregate distributions in excess of $112,500 ($45,000 + 
$200,000 - $112,500)............................................$132,500
(11) Amount subject to tax (lesser of (9) and (10))..............$61,250
(12) Amount of tax (15% of (11)...................................$9,187
(13) Unrecovered grandfather amount as of 12/31/87 ((3) - (8)) 
                                                                $616,250

                            c. Special Rules

    c-1: Q. How is the excise tax computed if a person elects special 
tax treatment under section 402 or 403 for a lump sum distribution?
    A. (a) General rule--(1) Conditions. Section 4981A(c)(4) provides 
for a special tax computation that applies to an individual in a 
calendar year if the individual receives distributions that include a 
lump sum distribution and the individual makes certain elections under 
section 402 or 403 with respect to that lump sum distribution (lump sum 
election).
    (2) Lump sum election. A lump sum election includes an election of 
(i) 5-year income averaging under section 402(e)(4)(B); (ii) phaseout 
capital gains treatment under sections 402(a)(2) or 403(a)(2) prior to 
their repeal by section 1122(b) of TRA '86 and as permitted under 
section 1122(h)(4) of TRA '86; (iii) grandfathered long-term capital 
gains under sections 402(a)(2) and 403(a) prior to such repeal and as 
permitted by section 1122(h)(3) of TRA '86; and (iv) grandfathered 10-
year income averaging under section 402(e) (including such treatment 
under a section 402(e)(4)(L) election) prior to amendment by section 
1122(a) of TRA '86 and as permitted by section 1122(h)(3)(A)(ii) and (5) 
of the TRA '86.
    (3) Special tax computation. (i) If the conditions in paragraph 
(a)(1) of this Q&A c-1 are satisfied for a calendar year, the rules of 
this subparagraph

[[Page 395]]

(a)(3) apply for purposes of determining whether there are excess 
distributions and tax under section 4981A.
    (ii) All distributions are divided into two categories. These two 
categories are the lump sum distribution and other distributions. 
Whether or not a particular distribution is a distribution subject to 
section 4981A and is in either category is determined under the rules in 
section 4981A and this section. Thus, the exclusions under section 
4981A(c)(2) and Q&A a-4(a) of this section apply here. For example, a 
distribution that is a tax-free recovery of employee contributions is 
not in either category.
    (iii) The excise tax under section 4981A(c)(1) is computed in the 
normal manner except that (A) it is the sum of the otherwise applicable 
taxes determined separately for the two categories of excess 
distributions and (B) a different amount (threshold amount) is 
subtracted from the distributions in each category in determining the 
amount of the excess distributions. The threshold amount that is 
subtracted from the portion of the distributions that is not part of the 
lump sum distribution is the applicable threshold amount, determined 
without regard to section 4981A(c)(4) and the lump sum election. Thus, 
the threshold amount subtracted from the amount in this category is 
either the $150,000 amount or the $112,500 amount (indexed). The 
threshold amount that is subtracted from the amount of the lump sum 
distribution is 5 times the applicable threshold amount as described 
above. Thus, the threshold amount subtracted from the lump sum 
distribution is $750,000 or 5 times $112,500 indexed (initially 
$562,500).
    (b) Grandfather rule--(1) In general. This paragraph (b) provides 
special rules where an individual makes both the grandfather election 
described in section 4981A(c)(5) and the lump sum election described in 
paragraph (a) of this Q&A c-1. See Q&A b-11 through 14 for other rules 
that apply to such grandfather election.
    (2) Discretionary method. If the individual uses the discretionary 
method, described in Q&As b-11 and 12 of this section, the applicable 
threshold amount is $112,500 (indexed). Under this method, the 
grandfather amount is recovered at a 10 percent or 100 percent rate in 
any calendar year and is offset separately against distributions in each 
category of distributions at the appropriate rate. If, for any calendar 
year, distributions are received in both categories and the total of the 
appropriate percentage (10 percent or 100 percent) of the distributions 
in each category exceed the unrecovered grandfathered account, then such 
grandfather amount must be recovered ratably from the distributions in 
each category. This rule applies even if the distributions in one 
category are less than the threshold amount for that category and the 
distributions in the other category exceed the threshold amount for that 
category.
    (3) Attained age method. If the individual uses the attained age 
method, described in Q&As b-11 and 13 of this section, the threshold 
amount is $112,500 (indexed). Under this method, to determine the 
portion of the distributions in each category that is treated as a 
recovery of the grandfather amount, the fraction described in Q&A b-13 
of this section is applied separately to the distributions in each 
category of distributions. If, for any calendar year, distributions are 
received in both categories and the total of the amounts of the 
distributions in each category that are treated as a recovery of the 
grandfather amount exceeds that undercovered grandfather amount, then 
such grandfather amount must be recovered ratably from the distributions 
in each category. This rule applies even if the distributions in one 
category are less than the threshold amount for that category and the 
distributions in the other category exceed the threshold amount for that 
category.
    (c) Amount in lump sum category. All amounts received from the 
employer that are required to be distributed to the individual in order 
to make a lump sum election described in paragraph (a) of this Q&A c-1 
are included in the lump sum category. Amounts are in the lump sum 
category even though they are not subject to income tax under the 
election. Thus, for example, the following amounts would be in the lump 
sum category: (1) Appreciation on employer securities received as part 
of

[[Page 396]]

a distribution for which a lump sum treatment is elected; and (2) 
amounts that are phased out when section 1122 of TRA '86 is elected. 
However, accumulated deductible employee contributions under the plan 
(within the meaning of section 72(o)(5)) are in the nonlump sum 
category.
    (d) Examples. The rules in this Q&A c-1 are illustrated by the 
following examples:

    Example 1. (a) On January 1, 199X, individual A who is age 65 and is 
a calendar year taxpayer receives a lump sum distribution described in 
section 402(e)(4)(A) from a qualified employer plan (Plan X). A receives 
no other distribution in 199X. A elects 5-year income averaging under 
section 402(e)(4)(B) and also elects section 402(e)(4)(L) treatment 
(treating pre-74 participation as post-1973 participation) on A's income 
tax return for 199X. Thus, A also makes the lump sum election described 
in paragraph (a)(2), above. For 199X, the $112,500 threshold amount 
indexed is $125,000. A does not make a grandfather election so that A's 
threshold amount is $150,000.
    (b) A's distribution from Plan X consists of cash in the amount of 
$800,000. A has a section 72(f) investment in the contract. A has over 
the years made after tax contributions to Plan X of $50,000. A's 
distributions subject to section 4981A equal $750,000 because of the 
exclusion of A's $50,000 after-tax contributions.
    (c) A's distributions consist solely of amounts in the lump sum 
category. A's threshold amount equals $750,000 under the rules of this 
paragraph (a)(iii), above, (5 times $150,000). Because A's threshold 
amount ($750,000) equals the amount of A's distribution from Plan X 
($750,000) no part of A's distribution from Plan X is treated as an 
excess distribution subject to the 15-percent excise tax.
    Example 2. (a) Assume the same facts as in Example (1), except that 
A receives an additional distribution from an individual retirement plan 
described in section 408(a) (IRA Y) in 199X of $150,000. A has made no 
nondeductible contributions to IRA Y and all of the $150,000 is a 
distribution subject to section 4981A.
    (b) A's distributions consist of two categories, the lump sum 
category (Plan X $750,000) and the other than lump sum category (IRA Y 
$150,000). A separate threshold amount is subtracted from A's IRA Y 
distribution. This threshold amount equals $150,000 under the rules of 
this paragraph (a)(3), above, the same initial threshold amount that is 
applied against the lump sum prior to the multiplication by 5). Because 
A's threshold amount ($150,000) equals the amount of A's distribution 
from IRA Y ($150,000), no part of A's distribution from IRA Y would be 
treated as an excess distribution subject to the 15-percent excise tax.
    Example 3. (a) Assume the same facts as in Example (2), except that 
A's distribution is $825,000 from Plan X, before reduction of $50,000 
for employee contributions, instead of $800,000, so that A's 
distribution subject to section 4981A from Plan X is $775,000. A made a 
valid grandfather election. Therefore, the applicable threshold amount 
is $125,000 ($112,500 indexed for 199X). A's unrecovered grandfather 
amount as of the end of the year preceding 199X is $1,000,000 (A had a 
benefit under another retirement plan (Plan Z) on August 1, 1986, and 
A's account balance under Plan Z, which is a stock bonus plan, is 
$6,000,000 on January 1, 199X.) A also made a valid election of the 
discretionary method to recover A's grandfather amount.
    (b) If A recovers A's grandfather amount in 199X at the 10 percent 
rate, 10 percent of A's distributions that are in the lump sum category 
(Plan X $775,000) is treated as a recovery of A's grandfather amount. 
Similarly, 10 percent of A's distributions that are in the other than 
lump sum category (IRA Y $150,000) is treated as a recovery of A's 
grandfather amount. Thus, A's grandfather amount is reduced by $92,500 
($77,500 Plan X and $15,000 IRA Y) for the 199X calendar year and is 
$907,500 on January 1 of the year following 199X. Because the amounts of 
the distributions in each category that are treated as a recovery of 
grandfather amount are less than the applicable threshold amount for 
each category ($625,000 Plan X, $125,000 IRA Y), the recovery of the 
grandfather amount does not affect the calculations of the 199X excise 
tax.
    (c) Because A's distribution from IRA Y of $150,000 exceeds A's 
threshold amount of $125,000 ($112,500 indexed) applicable to nonlump 
sum distributions by $25,000 and A's distribution subject to section 
4981A from Plan X of $775,000 exceeds A's threshold amount of $625,000 
(5X$125,000) applicable to lump sums by $150,000, A is subject to the 
15-percent excise tax. A's tax under section 4981A is $26,250 (15 
percent of $25,000 plus 15 percent of $150,000).
    Example 4. (a) Assume the same facts as in Example (3) except that A 
makes a valid acceleration election under the discretionary method with 
respect to A's grandfather amount of $1,000,000 for calendar year 199X.
    (b) Because A's grandfather amount on January 1, 199X ($1,000,000) 
equals or exceeds A's distribution subject to section 4981A ($925,000) 
for 199X, no part of A's distribution from Plan X or IRA Y would be 
treated as excess distribution subject to the 15-percent excise tax.
    (c) A's distributions subject to 4981A from Plan X of $775,000 and 
from IRA Y of $150,000 are offset 100 percent by A's grandfather

[[Page 397]]

amount of $1,000,000. Therefore, A's grandfather amount on January 1 of 
the year following 199X is $75,000 ($1,000,000 minus $925,000). This 
$75,000 would be required to be offset 100 percent against any 
distributions received in that year.
    Example 5. (a) Assume the same facts as in Example (4), except that 
A's distribution subject to section 4981A from Plan X, after reduction 
of the $50,000 for employee contributions, is $1,000,000 and from IRA Y 
is $125,000 (equal to the threshold amount), totaling $1,125,000.
    (b) Because the sum of the amount received in the lump sum category 
and the other than lump sum category of distributions is greater than 
the grandfather amount ($1,000,000), the grandfather amount must be 
allocated to each separate category on the basis of the ratio of the 
amount received in each category to the sum of these amounts. Thus, 
$888,889 ($1,000,000 X ($1,000,000 divided by $1,125,000)) is allocated 
to the lump-sum category and $111,111 ($1,000,000 X ($125,000 divided by 
$1,125,000)) is allocated to the other than lump sum category. A's 
distributions of $1,000,000 in the lump sum category are reduced by 
$888,889, the greater of $625,000 (the threshold amount) or $888,889 
(grandfather amount), and equal $111,111. A's excise tax is $16,666 (15 
percent of $111,111). A owes no excess distribution tax on the $125,000 
received from IRA Y because it is fully offset by the threshold amount 
of $125,000.
    (c) Because A's distribution subject to section 4981A for the year 
of $1,125,000 ($1,000,000 plus $125,000) exceeds A's grandfather amount 
on January 1, 199X of $1,000,000, A's grandfather amount is zero for all 
subsequent calendar years.

    c-2: Q. Must retirement plans be amended to limit future benefits 
accruals so that the amounts that are distributed would not be subject 
to an excise tax under section 4981A?
    A. No. A qualified employer plan need not be amended to reduce 
future benefits so that the amount of annual aggregate distributions are 
not subject to tax under section 4981A. Section 415 does, however, 
require plan provisions that limit the accrual of benefits and 
contributions to specified amounts. The operation of the excise tax of 
section 4981A is independent of plan qualification requirements limiting 
benefits and contributions under qualified plans.
    c-3: Q. Is a plan amendment reducing accrued benefits a permitted 
method of avoiding the excise tax?
    A. No. Accrued benefits may not be reduced to avoid the imposition 
of the excise tax. Such reduction would violate employer plan 
qualification requirements, including section 411(d)(6).
    c-4: Q. To what extent is the 15 percent section 4981A tax reduced 
by the 10 percent section 72(t) tax?
    A. (a) General rule. The 15 percent tax on excess distributions may 
be offset by the 10 percent tax on early distributions to the extent 
that the 10 percent tax is applied to excess distributions. For example, 
assume that individual (A), age 56, receives a distribution of $200,000 
from a qualified employer plan (Plan X) during calendar year 1987. 
Further, assume that the entire distribution is subject to the 10-
percent tax of section 72(t). A tax of $20,000 (10% of $200,000) is 
imposed on the distribution under section 72(t). Assuming that the 
distribution is not a lump sum distribution eligible for special tax 
treatment under section 402, part of the distribution is subject to tax 
under section 4981A. If A does not elect the special grandfather rule, 
A's dollar limitation is $150,000 and the amount of $200,000 
distribution that is an excess distribution is $50,000 ($200,000-
$150,000). The 15 percent tax is $7,500 (15% of $50,000). The portion of 
the $20,000 section 72(t) tax on early distributions that is 
attributable to the excess distribution is $5,000 (10% of $50,000). This 
amount is credited against the section 4981A tax. Therefore, the total 
tax imposed on the distribution under both provisions is $22,500 
($20,000 + ($7,500-$5,000)).
    (b) Example. (1) If some, but not all, distributions made for a 
calendar year are subject to the section 72(t) tax, the offset is 
applied only to the extent that the section 72(t) tax applies to amounts 
that exceed the applicable threshold amount for that calendar year. For 
example, assume that during 1987 individual B receives a distribution of 
$40,000 that is not subject to the 10 percent section 72(t) tax and a 
separate distribution of $160,000 that is subject to the 10 percent 
section 72(t) tax. A tax of $16,000 (10% of $160,000) is imposed by 
section 72(t). Excess distributions for the year, assuming B does not 
elect the special grandfather rule, are $50,000 ($40,000 + $160,000-
$150,000). The tax under section 4981A is $7,500 (15% of $50,000). For 
purposes of determining

[[Page 398]]

the extent to which the 10 percent tax is applied to excess 
distributions, the only amounts subject to the 10 percent tax that are 
taken into account are distributions in excess of $150,000 (or if 
greater, the $112,500 (indexed) threshold for the year). The amount of 
distributions for 1987 to which the 10 percent tax is applicable 
($160,000) exceeds $150,000 by $10,000. Thus, the portion of the section 
72(t) tax of $16,000 that is attributable to excess distributions equals 
$1,000 (10 percent of $10,000). This amount is credited against the 
section 4981A tax. The total tax payable under the provisions of 
sections 72(t) and 4981A is $22,500 ($16,000 + ($7,500-$1,000)).
    (c) Net unrealized appreciation. A distribution consisting of net 
unrealized appreciation of employer securities that is excluded from 
gross income is not subject to section 72(t) and, therefore, there is no 
section 72(t) tax on such distribution that may be used to offset the 
tax on excess distributions.
    c-5: Q. If a distribution that is subject to both the 10 percent tax 
on early distributions from qualified plans imposed under section 72(t) 
and the 15 percent tax on excess distributions imposed under section 
4981A is received by an individual who elects to calculate the 15 
percent tax using the special grandfather rule, how is the offset of the 
10 percent tax imposed under section 72(t) calculated?
    A. The section 4981A tax is reduced only by the amount of the 10 
percent tax that is attributable to the portion of the distribution to 
which the section 4981A tax applies. For example, assume that (a) an 
individual (A), age 57, receives during 199X a distribution from a 
qualified plan of $325,000 that is subject to the 10 percent section 
72(t) tax; (b) the distribution is not a lump sum distribution and is 
subject to the 15 percent excise tax imposed by section 4981A; (c) A has 
elected to use the special grandfather rule; and (d) A accelerates the 
rate of recovery of the remaining grandfather amount of $250,000 so that 
only $75,000 of this distribution is subject to the section 4981A tax. 
Thus, the section 4981A tax is $11,250 (15% of $75,000). The portion of 
the section 72(t) 10 percent tax that is offset against the section 
4981A tax of $11,250 is limited to $7,500 (10% of $75,000), the section 
72(t) tax on the amount of distributions after taking into account the 
reduction under the grandfather rule.
    c-6: Q. When do distributions become subject to the excise tax under 
section 4981A?
    A. (a) General rule. Excess distributions made after December 31, 
1986, are subject to the excise tax under section 4981A.
    (b) Transitional rule--(1) Termination. Distributions prior to 
January 1, 1988, made on account of certain terminations of a qualified 
employer plan are not subject to tax under section 4981A. For a plan 
termination to be eligible for this transitional rule, the plan 
termination must occur before January 1, 1987. For purposes of applying 
the rules of section 4981A (except the reporting requirements), any such 
distribution is treated as if made on December 31, 1986. The 
distribution of an annuity contract is not an excepted distribution. See 
Q&A a-5 of this section.
    (2) Lump sum distributions. A lump sum distribution that an 
individual who separates from service in 1986 receives in calendar year 
1987 before March 16 is treated as a distribution received in 1986 if 
such individual elects to treat it as received in 1986 under the 
provisions of section 1124 of TRA '86. Thus, such a qualifying section 
1124 distribution is not subject to tax under section 4981A for 1987. 
For purposes of applying the rules of section 4981A, the amount 
attributable to such distribution is included in the individual's August 
1, 1986 accrued benefit and such distribution is treated as if made on 
December 31, 1986.
    (3) Grandfather amount recovery. If an individual described in this 
paragraph elects the special grandfather rule, the entire amount of 
distributions described in subparagraph (1) or (2) of this paragraph (b) 
is treated as a recovery of the individual's grandfather amount because 
it is treated as received on December 31, 1986. Thus, the individual's 
outstanding grandfather amount as of the date of the distribution is 
reduced by the amount of such distribution.
    c-7: Q. How is the tax on excess distributions or on excess 
accumulations under section 4981A reported?

[[Page 399]]

    A. (a) Tax on excess distributions. An individual liable for tax on 
account on excess distributions under section 4981A must complete Form 
5329 and attach it to his income tax return for the taxable year 
beginning with or within the calendar year during which the excess 
distributions are received. The amount of the tax is reported on such 
form and in such manner as prescribed by the Commissioner.
    (b) Tax on excess accumulations--(1) General rule. If, with respect 
to the estate of any individual, there is a tax under section 4981A(d) 
on account of the individual's excess accumulations, the amount of such 
tax is reported on Schedule S (Form 706 or 706NR). Schedule S must be 
filed on or before the due date under section 6075 including extensions, 
for filing the estate tax return. The tax under section 4981A(d) must be 
paid by the otherwise applicable due date for paying the estate tax 
imposed by chapter 11 even if, pursuant to section 6018(a), no return is 
otherwise required with respect to the estate tax imposed by chapter 11.
    (2) Earliest due date. Notwithstanding paragraph (b)(1) of this c-7, 
the due date for filing Schedule S (Form 706) and paying the tax on 
excess accumulations under section 4981A(d) is not earlier than February 
1, 1988. Thus, with respect to the estates of individuals dying in 
January through April of 1987, the due date for filing Schedule S (Form 
706) and paying any tax owed under section 4981A(d) is not earlier than 
February 1, 1988, even if the due date for filing the Schedule 706 and 
paying the estate tax imposed by chapter 11 is an earlier date. Further, 
no interest or penalties will be charged for failure to pay any tax on 
excess accumulations under section 4981A before January 31, 1988.
    c-8: Q. Does the fact that the benefits under a qualified retirement 
plan or individual retirement account are community property affect the 
determination of the excise tax under section 4981A?
    A. Generally, no. The operation of community property law is 
disregarded in determining the amount of aggregate annual distributions. 
Thus, the excise tax under section 4981A is computed without regard to 
the spouse's community property interest in the individual's or 
decedent's distributions or accumulation. Also, any reporting to the 
individual by a trustee, must be done on an aggregate basis without 
regard to the community property law.

                         d. Excess Accumulations

    d-1: Q. To what extent does section 4981A increase the estate tax 
imposed by chapter 11 with respect to the estates of any decedents?
    A. Section 4981A(d) provides that the estate tax imposed by chapter 
11 with respect to the estate of any decedent is increased by an amount 
equal to 15 percent of the decedent's excess accumulation. See Q&A d-2 
through d-7 of this section for rules for determining the decedent's 
excess accumulation. See Q&A d-8 of this section concerning credits 
under section 2010 through 2016. See Q&A d-9 of this section for 
examples illustrating the determination of the increase in estate tax 
under section 4981A(d).
    d-2: Q. How is the amount of a decedent's excess accumulation 
determined?
    A. (a) General rule. A decedent's excess accumulation is the excess 
of (1) the aggregate value of the decedent's interests in all qualified 
employer plans and individual retirement plans (decedent's aggregate 
interest) as of the date of the decedent's death over (2) an amount 
equal to the present value of a hypothetical life annuity determined 
under Q&A d-7 of this section. If the personal representative for the 
individual's estate elects to value the property in the gross estate 
under section 2032, the applicable valuation date prescribed by section 
2032 shall be substituted for the decedent's date of death.
    (b) Other rules. See Q&A d-3 and d-4 of this section if the decedent 
or, where appropriate, the decedent's personal representative validly 
elects the special grandfather rule and has any unused grandfather 
benefit as of the date of his death. See Q&A d-5 and d-6 of this section 
to determine the decedent's aggregate interest.
    d-3: Q. Does the special grandfather rule apply for purposes of 
determining the amount of the decedent's excess accumulation?

[[Page 400]]

    A. Yes. If a decedent prior to death (or the decedent's personal 
representative after death) makes an election that satisfied the 
procedures in Q&A b-3 of this section, the special grandfather rule 
applies.
    d-4: Q. How is the decedent's excess accumulation determined if the 
special grandfather rule applies?
    A. If the special grandfather rule applies, the decedent's excess 
accumulation is the excess of (a) the decedent's aggregate interest 
(determined under Q&A d-5 of this section) over (b) the greater of (1) 
the decedent's remaining unrecovered grandfather amount as of the date 
of the decedent's death, or (2) an amount equal to the present value of 
a hypothetical life annuity under Q&A d-7 of this section.
    d-5. Q. How is the value of the decedent's aggregate interest as of 
the applicable valuation date under Q&A d-2 determined?
    A. (a) Method of valuation. The value of the decedent's aggregate 
interest on the decedent's date of death is determined in a manner 
consistent with the valuation of such interests for purposes of 
determining the individual's gross estate for purposes of chapter 11. If 
the personal representative for an individual's estate subject to estate 
tax elects to value the property in the gross estate under section 2032, 
the decedent's aggregate interest is valued in a manner consistent with 
the rules prescribed by section 2032 (and other relevant estate tax 
sections). No adjustments provided in chapter 11 in valuing the gross 
estate are made. Thus, there is no adjustment under section 2057 
(relating to the sale of certain employer securities).
    (b) Amounts included. Generally, all amounts payable to 
beneficiaries of the decedent under any qualified employer plan 
(including amounts payable to a surviving spouse under a qualified joint 
and survivor annuity or qualified preretirement survivor annuity) or 
individual retirement plan, whether or not otherwise included in valuing 
the decedent's gross estate, are considered to be part of the decedent's 
interest in such plan.
    (c) Rollover after death. If any amount is distributed from a 
qualified employer plan or individual retirement plan within the 60-day 
period ending on the decedent's date of death and is rolled over to an 
IRA after such date but within 60 days of the date distributed, the 
decedent's aggregate interest is increased by the amount rolled over, 
valued as of the date received by the IRA.
    d-6. Q. Are there any reductions in the decedent's aggregate 
interest?
    A. The decedent's aggregate interest is reduced by the following:
    (a) Amount payable to alternate payee. The amount of any portion of 
the deceased individual's interest in a qualified employer plan that is 
payable to an alternate payee in whose income the amount is includible 
under a qualified domestic relations order within the meaning of section 
414(p) (QDRO). However, such portion must be taken into account in 
determining the excess distribution or the excess accumulation upon the 
death of such alternate payee for purposes of determining if there is a 
tax under section 4981A(a) or an increase in the estate tax under 
section 4981A(d) with respect to such alternate payee.
    (b) Investment in the contract. The amount of the deceased 
individual's unrecovered investment, within the meaning of section 
72(f), in any qualified employer plan or individual retirement plan.
    (c) Life insurance proceeds. The excess of any amount payable by 
reason of the death of the individual under a life insurance contract 
held under a qualified employer plan over the cash surrender value of 
such contract immediately before the death of such individual (the 
amount excludible from income by reason of section 101(a)). Amounts 
excludible from gross income because of section 101(b) do not reduce the 
decedent's aggregate interest.
    (d) Interest as a beneficiary. The amount of the deceased 
individual's interest in a qualified retirement plan or individual 
retirement plan by reason of the death of another individual.
    d-7. Q. How is the present value of the hypothetical life annuity 
determined?
    A. (a) General rule. The hypothetical life annuity is a single life 
annuity contract that provides for equal annual annuity payments 
commencing on the

[[Page 401]]

decedent's date of death for the life of an individual whose age is the 
same as the decedent's determined as of the date of the decedent's 
death. The amount of each annual payment is equal to the greater of 
$150,000 (unindexed) and $112,500 (as indexed until the date of death). 
If the decedent elected (or the decedent's personal representative 
elects) the special grandfather rule, the amount of each annual payment 
is $112,500 (as indexed until the date of death) even if there is no 
remaining grandfather amount.
    (b) Determination of age. The decedent's age as of the decedent's 
date of death for purposes of valuing the hypothetical life annuity is 
the decedent's attained age (in whole years) as of the decedent's date 
of death. For example, if the decedent was born on February 2, 1930, and 
died on August 3, 1990, the decedent's age for purposes of valuing the 
hypothetical life annuity is 60.
    (c) Interest rate assumptions. The present value of the single life 
annuity described above must then be calculated using the interest rate 
and mortality assumptions in Sec. 20.2031-7 of the Estate Tax 
Regulations in effect on the date of death.
    d-8: Q. Are any credits, deductions, exclusions, etc. that apply for 
estate tax purposes allowable as an offset against the excise tax under 
section 4981A(d) for excess accumulations?
    A. No. No credits, deductions, exclusions, etc. that apply for 
estate tax purposes are allowed to offset the tax imposed under section 
4981A(d). Thus, no credits under section 2010 through 2016 or other 
reductions permitted by Chapter 11 are allowable against the tax under 
section 4981A(d) for excess accumulations. For example, no credits are 
allowable for the unified credit against the estate tax, for state death 
taxes, or for gift taxes.
    d-8A. Q. Is the estate liable for the excise tax of 15 percent on 
the amount of the decedent's excess accumulations?
    A. Yes. In all events, the estate is liable for the excise tax of 15 
percent on the amount of the decedent's excess accumulations. Transferee 
liability rules under chapter 11 do apply, however. Similarly, the 
reimbursement provisions of section 2205 also apply. Additionally, the 
rules generally applicable for purposes of determining the apportionment 
of the estate tax apply to the apportionment of the excise tax under 
section 4981A(d). Thus, the decedent's will or the applicable state 
apportionment law may provide that the executor is entitled to recover 
the tax imposed under section 4981A(d) attributable to any property from 
the beneficiary entitled to receive such property. However, absent such 
a provision in the decedent's will or in the applicable state 
apportionment law, the executor is not entitled to recover the tax 
imposed under section 4981A(d) attributable to any property from the 
beneficiary entitled to receive such property.
    d-9: Q. How is the additional tax computed with respect to a 
decedent's estate under section 4981A(d)?
    A. The determination of the additional tax under section 4981A(d) is 
illustrated by the following examples:

    Example 1. (a) An individual (A) dies on February 1, 199X at age 70 
and 9 months. As of A's date of death, A has an interest in a defined 
benefit plan described in section 401(a) (Plan X). Plan X has never 
provided for employee contributions. A has no section 72 (f) investment 
in Plan X. A does not have any interest in any other qualified employer 
plan or individual retirement plan. The alternate valuation date in 
section 2032 does not apply. A did not elect to have the special 
grandfather rule apply. A's interest in Plan X is in the form of a 
qualified joint and survivor annuity. The value of the remaining 
payments under the joint and survivor annuity as of A's date of death 
(determined under D-5) is $2,000,000.
    (b) Because A is age 70 and 9 months of A's date of death, A's life 
expectancy as of A's date of death is calculated using age 70 (A's 
attained age in whole years on A's date of death). The factor from Table 
A of Sec. 20.2031-7(f) used to determine the present value of a single 
life annuity for an individual age 70 is 6.0522. The greater of $150,000 
or $112,500 indexed for 199X is 150,000. The present value of the 
hypothetical single life annuity is $907,830 ($150,000x6.0522)
    (c) The amount of A's excess accumulation is $1,092,170, determined 
as follows: $2,000,000 (value of A's interest in Plan X) minus $907,830 
(value of hypothetical single life annuity contract) equals $1,092,170.
    (d) The increase in the estate tax under section 4981A(d) is 
$163,825 (15 percent of $1,092,170).

[[Page 402]]

    Example 2. (a) The facts are the same as in Example 1, except that 
A's interest in Plan X consists of the following:
    (1) $2,000,000, value of employer-provided portion of a qualified 
joint and survivor annuity determined as of A's date of death using the 
interest and mortality assumptions in Sec. 20.2031-7.
    (2) $200,000, proceeds of a term life insurance contract (no cash 
surrender value before death).
    (3) $100,000. amount (employer-provided portion) payable to A's 
former spouse pursuant to a QDRO.
    (4) $100,000, amount of A's investment in Plan X.
    (b) The value of A's interest in Plan X for purposes of calculating 
A's excess accumulation is still $2,000,000. The proceeds of the term 
life insurance contract, the amount payable under the QDRO, and the 
amount of A's investment in Plan X are excluded from such value.
    Example 3. (a) The facts are the same as in Example 1, except that A 
elected the special grandfather rule. A's initial grandfather amount was 
$1,100,000. As of A's date of death, A had received $500,000 in 
distributions that were treated as a return of A's grandfather amount. 
Thus, A's unused grandfather amount is $600,000 ($1,100,000-$500,000). 
In 199X, assume that $112,500 indexed is still $112,500.
    (b) A's excess retirement accumulation is determined as follows: 
$2,000,000 minus the greater of (1) $600,000 or (2) the present value of 
a period certain annuity of $112,500 a year for 16 years. The present 
value of a single life annuity of $112,500 a year for an individual age 
70 is determined as follows: $112,500 x 6.0522=$680,827.25. $680,827.25 
is greater than $600,000. Thus the amount of the excess retirement 
accumulation is $1,319,173 ($2,000,000 minus $680,827).
    (c) The additional estate tax under section 4981A(d) is $197,875 (15 
percent of $1,319,173).
    Example 4. (a) The facts are the same as in Example 3 except that, 
as of A's date of death, A received $90,000 in distributions that were 
treated as a return of A's grandfather amount. Thus, A's unused 
grandfather amount is $1,010,000 ($1,100,000-$90,000).
    (b) A's excess retirement accumulation is determined as follows: 
$2,000,000 minus the greater of (1) ($1,010,000 (A's unused grandfather 
amount) or (2) 680,827.25 (the present value of a single life annuity of 
$112,500 a year for an individual age 70). A's unused grandfather amount 
is greater than the present value of the hypothetical life annuity. 
Thus, the amount of the excess retirement accumulation is $990,000 
($2,000,000-$1,010,000).
    (c) The additional estate tax under section 4981A(d) is $148,500 (15 
percent of $990,000).

    d-10: Q. if a surviving spouse rolls over a distribution from a 
qualified retirement plan or an individual retirement plan of the 
decedent to an individual retirement plan (IRA) established in the 
spouse's own name, is any distribution in a calendar year from the IRA 
receiving such rollover included in determining the spouse's excess 
distribution or excess accumulation in such calendar year?
    A. (a) General rule. If a surviving spouse rolls over a distribution 
from a qualified retirement plan or an individual retirement plan of the 
decedent to an individual retirement plan (IRA) established in the 
spouse's own name with the rollover contribution and no other 
contributions or transfers are made to the IRA receiving the rollover 
contribution, distributions from such IRA will be excluded in 
determining the spouse's excess distributions and the value of the IRA 
will be excluded in determining the spouse's excess accumulation. If the 
surviving spouse rolls over a distribution from a qualified retirement 
plan or IRA of the decedent to an IRA for which the spouse has prior 
contributions or makes additional contributions to the IRA receiving the 
distribution, distributions from the IRA will be included in determining 
the amount of the excess distributions received by the spouse for the 
calendar year of the distribution and the value of the IRA at the 
applicable valuation date will be included in determining the spouse's 
excess accumulation.
    (b) Special rules. The rule in paragraph (a) of this Q&A d-10 also 
applies if a surviving spouse elects to treat an inherited IRA 
(described in section 408(d)(3)(C)(ii)) as the spouse's own IRA as long 
as the surviving spouse makes no further contributions to such IRA.
    (c) Other beneficiaries. Rules similar to the rules in paragraphs 
(a) and (b) shall apply to an individual who elected to treat an IRA as 
subject to the distribution requirements of section 408(a)(6), prior to 
amendment by section 521(b) of TRA '84, under Sec. 1.408-2(b)(7)(ii) of 
the Income Tax Regulations.
    d-11. Q. To what estates does the excise tax under section 4981A(d) 
apply?

[[Page 403]]

    A. The excise tax under section 4981A(d) applies to estates of 
decedents dying after December 31, 1986.
    d-12: Q. Is the aggregate interest reduced by distributions 
described in paragraph (b)(1) of Q&A c-6 of this section (distributions 
prior to January 1, 1988, made on account of certain terminations of a 
qualified employer plan) which are made after the individual's death.
    A. Yes, the value of the individual's aggregate interest determined 
under Q&A d-5 of this section is reduced by distributions described in 
paragraph (b)(1) of Q&A c-6 of this section which are made after the 
individual's death.

[T.D. 8165, 52 FR 46750, Dec. 10, 1987; 53 FR 18975, May 26, 1988]



Sec. 54.6011-1  General requirement of return, statement, or list.

    (a) Minimum funding standards or excess contributions for self-
employed individuals and section 403(b)(7)(A) custodial accounts. Any 
employer or individual liable for tax under section 4971, 4972 or 
4973(a)(2) (for a custodial account under section 403(b)(7)(A)) shall 
file an annual return on Form 5330 and shall include therein the 
information required by such form and the instructions issued with 
respect thereto.
    (b) Tax on prohibited transactions. Every disqualified person (as 
defined in section 4975(e)(2)) liable for the tax imposed under section 
4975(a) with respect to a prohibited transaction shall file an annual 
return on Form 5330 and shall include therein the information required 
by such form and the instructions issued with respect thereto. The 
annual return on Form 5330 shall be filed with respect to each 
prohibited transaction and for each taxable year (or part thereof) of 
the disqualified person in the taxable period (as defined in section 
4975(f)(2)) beginning on the date on which such prohibited transaction 
occurs.
    (c) Entity manager tax on prohibited tax shelter transactions--(1) 
In general. Any entity manager of a tax-exempt entity described in 
section 4965(c)(4), (c)(5), (c)(6), or (c)(7) who is liable for tax 
under section 4965(a)(2) shall file a return on Form 5330, ``Return of 
Excise Taxes Related to Employee Benefit Plans,'' on or before the 15th 
day of the fifth month following the close of such entity manager's 
taxable year during which the entity entered into the prohibited tax 
shelter transaction, and shall include therein the information required 
by such form and the instructions issued with respect thereto.
    (2) Transition rule. A Form 5330, ``Return of Excise Taxes Related 
to Employee Benefit Plans,'' for an excise tax under section 4965 that 
was due on or before October 4, 2007, will be deemed to have been filed 
on the due date if it was filed by October 4, 2007, and if the section 
4965 tax that was required to be reported on that Form 5330 was paid by 
October 4, 2007.
    (d) Effective/applicability date. Paragraph (c) of this section is 
applicable on July 6, 2007.

[T.D. 7838, 47 FR 44249, Oct. 7, 1982, as amended by T.D. 9334, 72 FR 
36873, July 6, 2007; T.D. 9492, 75 FR 38708, July 6, 2010; 75 FR 46845, 
Aug. 4, 2010]



Sec. 54.6011-1T  General requirement of return, statement, or list 
(temporary).

    (a) Tax on reversions of qualified plan assets to employer. Every 
employer liable for the tax imposed under section 4980(a) with respect 
to an employer reversion (as defined in section 4980(c)(2)) shall file a 
quarterly return on Form 5330 and shall include therein the information 
required by such form and the instructions issued with respect thereto. 
The quarterly return on Form 5330 shall be filed with respect to 
employer reversions from each qualified plan (as defined in section 
4980(c)(1)).
    (b) [Reserved]

[T.D. 8133, 52 FR 10563, Apr. 2, 1987 as amended by T.D. 9334, 72 FR 
36873, July 6, 2007; 72 FR 45895, Aug. 16, 2007; T.D. 9492, 75 FR 38709, 
July 6, 2010]



Sec. 54.6011-2  General requirement of return, statement, or list.

    Effective for any Form 8928 that is due on or after January 1, 2010, 
any person liable for tax under section 4980B, 4980D, 4980E, or 4980G of 
the Code shall file a return with respect to the tax on Form 8928. The 
return must include the information required by Form 8928 and the 
instructions issued with respect to it.

[T.D. 9457, 74 FR 45999, Sept. 8, 2009]

[[Page 404]]



Sec. 54.6011-4  Requirement of statement disclosing participation in
certain transactions by taxpayers.

    (a) In general. If a transaction is identified as a listed 
transaction or a transaction of interest as defined in Sec. 1.6011-4 of 
this chapter by the Commissioner in published guidance (see Sec. 
601.601(d)(2)(ii)(b) of this chapter), and the listed transaction or 
transaction of interest involves an excise tax under chapter 43 of 
subtitle D of the Internal Revenue Code (relating to qualified pension, 
etc., plans) the transaction must be disclosed in the manner stated in 
such published guidance.
    (b) Effective/applicability date. This section applies to listed 
transactions entered into on or after January 1, 2003. This section 
applies to transactions of interest entered into on or after November 2, 
2006.

[T.D. 9350, 72 FR 43154, Aug. 3, 2007]



Sec. 54.6060-1  Reporting requirements for tax return preparers.

    (a) In general. A person that employs one or more tax return 
preparers to prepare a return or claim for refund under Chapter 43 of 
subtitle D of the Internal Revenue Code, other than for the person, at 
any time during a return period, shall satisfy the record keeping and 
inspection requirements in the manner stated in Sec. 1.6060-1 of this 
chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78458, Dec. 22, 2008]



Sec. 54.6061-1  Signing of returns and other documents.

    Effective for any Form 8928 that is due on or after January 1, 2010, 
any return, statement, or other document required to be made with 
respect to a tax imposed by section 4980B, 4980D, 4980E, or 4980G of the 
Code or the regulations under section 4980B, 4980D, 4980E, or 4980G must 
be signed by the person required to file the return, statement, or other 
document, or by the persons required or duly authorized to sign in 
accordance with the regulations, forms, or instructions prescribed with 
respect to such return, statement, or document. An individual's 
signature on such return, statement, or other document shall be prima 
facie evidence that the individual is authorized to sign the return, 
statement, or other document.

[T.D. 9457, 74 FR 46000, Sept. 8, 2009]



Sec. 54.6071-1  Time for filing returns.

    (a) Returns under section 4980B. (1) Due date for filing of return 
by employers or other persons responsible for benefits under a group 
health plan. If the person liable for the excise tax is an employer or 
other person responsible for providing or administering benefits under a 
group health plan (such as an insurer or a third party administrator), 
the return required by Sec. 54.6011-2 must be filed on or before the 
due date for filing the person's income tax return and must reflect the 
portion of the noncompliance period for each failure under section 4980B 
that falls during the person's taxable year. An extension to file the 
person's income tax return does not extend the date for filing Form 
8928.
    (2) Due date for filing of return by multiemployer plans. If the 
person liable for the excise tax is a multiemployer plan, the return 
required by Sec. 54.6011-2 must be filed on or before the last day of 
the seventh month following the end of the plan's plan year. The filing 
of Form 8928 by a plan must reflect the portion of the noncompliance 
period for each failure under section 4980B that falls during the plan's 
plan year.
    (b) Returns under section 4980D. (1) Due date for filing of return 
by employers. If the person liable for the excise tax is an employer, 
the return required by Sec. 54.6011-2 must be filed on or before the 
due date for filing the employer's income tax return and must reflect 
the portion of the noncompliance period for each failure under chapter 
100 that falls during the employer's taxable year. An extension to file 
the employer's income tax return does not extend the date for filing 
Form 8928.
    (2) Due date for filing of return by multiemployer plans or multiple 
employer health plans. If the person liable for the excise tax is a 
multiemployer plan or a specified multiple employer health plan, the 
return required by Sec. 54.6011-2 must be filed on or before the last 
day of the seventh month following the end

[[Page 405]]

of the plan's plan year. The filing of Form 8928 by a plan must reflect 
the portion of the noncompliance period for each failure under chapter 
100 that falls during the plan's plan year.
    (c) Returns under section 4980E. Any employer who is liable for the 
excise tax under section 4980E must report this tax by filing the return 
required by Sec. 54.6011-2 on or before the 15th day of the fourth 
month following the calendar year in which the noncomparable 
contributions were made.
    (d) Returns under section 4980G. Any employer who is liable for the 
excise tax under section 4980E must report this tax by filing the return 
required by Sec. 54.6011-2 on or before the 15th day of the fourth 
month following the calendar year in which the noncomparable 
contributions were made. See Q & A-4 of Sec. 54.4980G-1 for the rules 
on computation of the excise tax under section 4980G.
    (e) Effective/applicability date: The rules in this section are 
effective for any Form 8928 that is due on or after January 1, 2010.

[T.D. 9457, 74 FR 46000, Sept. 8, 2009]



Sec. 54.6081-1  Automatic extension of time for filing returns for 
certain excise taxes under Chapter 43.

    (a) In general. An employer, other person or health plan that is 
required to file a return on Form 8928, ``Return of Certain Excise Taxes 
Under Chapter 43 of the Internal Revenue Code,'' will be allowed an 
automatic 6-month extension of time to file the return after the date 
prescribed for filing the return if the employer, other person or health 
plan files an application under this section in accordance with 
paragraph (b) of this section.
    (b) Requirements. To satisfy this paragraph (b), an employer, other 
person or health plan must--
    (1) Submit a complete application on Form 7004, ``Application for 
Automatic Extension of Time To File Certain Business Income Tax, 
Information, and Other Returns,'' or in any other manner prescribed by 
the Commissioner;
    (2) File the application on or before the date prescribed for filing 
the return with the Internal Revenue Service office designated in the 
application's instructions; and
    (3) Remit the amount of the properly estimated unpaid tax liability 
on or before the date prescribed for payment.
    (c) No extension of time for the payment of tax. An automatic 
extension of time for filing a return granted under paragraph (a) of 
this section will not extend the time for payment of any tax due on such 
return.
    (d) Termination of automatic extension. The Commissioner may 
terminate an automatic extension at any time by mailing to the employer, 
other person, or health plan a notice of termination at least 10 days 
prior to the termination date designated in such notice. The 
Commissioner must mail the notice of termination to the address shown on 
the Form 7004 or to the estate or trust's last known address. For 
further guidance regarding the definition of last known address, see 
Sec. 301.6212-2 of this chapter.
    (e) Penalties. See section 6651 for failure to file a pension excise 
tax return or failure to pay the amount shown as tax on the return.
    (f) Effective/applicability date. This section is applicable for 
applications for an automatic extension of time to file a return due 
under chapter 43, filed on or after June 24, 2011.

[T.D. 9531, 76 FR 36999, June 24, 2011]



Sec. 54.6091-1  Place for filing excise tax returns under section 
4980B, 4980D, 4980E, or 4980G.

    Effective for any Form 8928 that is due on or after January 1, 2010, 
the return required by Sec. 54.6011-2 must be filed at the place 
specified in the forms and instructions provided by the Internal Revenue 
Service.

[T.D. 9457, 74 FR 46000, Sept. 8, 2009]



Sec. 54.6107-1  Tax return preparer must furnish copy of return or 
claims for refund to taxpayer and must retain a copy or record.

    (a) In general. A person who is a signing tax return preparer of any 
return or claim for refund of tax under Chapter 43 of subtitle D of the 
Internal Revenue Code, shall furnish a completed copy of the return or 
claim for refund to the taxpayer, and retain a completed copy or record 
in the manner stated in Sec. 1.6107-1 of this chapter.

[[Page 406]]

    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78458, Dec. 22, 2008]



Sec. 54.6109-1  Tax return preparers furnishing identifying numbers 
for returns or claims for refund filed.

    (a) In general. Each tax return or claim for refund of tax under 
Chapter 43 of subtitle D prepared by one or more signing tax return 
preparers must include the identifying number of the preparer required 
by Sec. 1.6695-1(b) of this chapter to sign the return or claim for 
refund in the manner stated in Sec. 1.6109-2 of this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed after December 31, 
2008.

[T.D. 9436, 73 FR 78458, Dec. 22, 2008]



Sec. 54.6151-1  Time and place for paying of tax shown on returns.

    Effective for any Form 8928 that is due on or after January 1, 2010, 
the tax shown on any return which is imposed under section 4980B, 4980D, 
4980E or 4980G shall, without assessment or notice and demand, be paid 
to the internal revenue officer with whom the return is filed at the 
time and place for filing such return (determined without regard to any 
extension of time for filing the return). For provisions relating to the 
time and place for filing such return, see Sec. Sec. 54.6071-1 and 
54.6091-1.

[T.D. 9457, 74 FR 46000, Sept. 8, 2009]



Sec. 54.6694-1  Section 6694 penalties applicable to tax return preparer.

    (a) In general. For general definitions regarding section 6694 
penalties applicable to preparers of tax returns or claims for refund of 
tax under Chapter 43 of subtitle D, see Sec. 1.6694-1 of this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed, and advice provided, 
after December 31, 2008.

[T.D. 9436, 73 FR 78458, Dec. 22, 2008]



Sec. 54.6694-2  Penalties for understatement due to an unreasonable 
position.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under Chapter 43 of subtitle D of the 
Internal Revenue Code (Code) shall be subject to penalties under section 
6694(a) of the Code in the manner stated in Sec. 1.6694-2 of this 
chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78458, Dec. 22, 2008]



Sec. 54.6694-3  Penalty for understatement due to willful, reckless,
or intentional conduct.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of excise tax under chapter 43 of subtitle D of the 
Internal Revenue Code (Code) shall be subject to penalties under section 
6694(b) of the Code in the manner stated in Sec. 1.6694-3 of this 
chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78458, Dec. 22, 2008]



Sec. 54.6694-4  Extension of period of collection when tax return 
preparer pays 15 percent of a penalty for understatement of taxpayer's 

liability and certain other procedural matters.

    (a) In general. For rules relating to the extension of period of 
collection when a tax return preparer who prepared a return or claim for 
refund for tax under chapter 43 of subtitle D of the Internal Revenue 
Code pays 15 percent of a penalty for understatement of taxpayer's 
liability, and procedural matters relating to the investigation, 
assessment and collection of the penalties under section 6694(a) and 
(b), the rules under Sec. 1.6694-4 of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78459, Dec. 22, 2008]

[[Page 407]]



Sec. 54.6695-1  Other assessable penalties with respect to the 
preparation of tax returns for other persons.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under chapter 43 of subtitle D of the 
Internal Revenue Code (Code) shall be subject to penalties for failure 
to furnish a copy to the taxpayer under section 6695(a) of the Code, 
failure to sign the return under section 6695(b) of the Code, failure to 
furnish an identification number under section 6695(c) of the Code, 
failure to retain a copy or list under section 6695(d) of the Code, 
failure to file a correct information return under section 6695(e) of 
the Code, and negotiation of a check under section 6695(f) of the Code, 
in the manner stated in Sec. 1.6695-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78459, Dec. 22, 2008]



Sec. 54.6696-1  Claims for credit or refund by tax return preparers.

    (a) In general. For rules for claims for credit or refund by a tax 
return preparer who prepared a return or claim for refund for excise tax 
under chapter 43 of subtitle D of the Internal Revenue Code, the rules 
under Sec. 1.6696-1 of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78459, Dec. 22, 2008]



Sec. 54.7701-1  Tax return preparer.

    (a) In general. For the definition of a tax return preparer, see 
Sec. 301.7701-15 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78459, Dec. 22, 2008]



Sec. 54.9801-1  Basis and scope.

    (a) Statutory basis. This section and sections 54.9801-2 through 
54.9801-6, 54.9802-1, 54.9802-2, 54.9802-3T, 54.9811-1, 54.9812-1T, 
54.9831-1, and 54.9833-1 (portability sections) implement Chapter 100 of 
Subtitle K of the Internal Revenue Code of 1986.
    (b) Scope. A group health plan may provide greater rights to 
participants and beneficiaries than those set forth in these portability 
sections. These portability sections set forth minimum requirements for 
group health plans concerning:
    (1) Limitations on a preexisting condition exclusion period.
    (2) Certificates and disclosure of previous coverage.
    (3) Rules relating to creditable coverage.
    (4) Special enrollment periods.
    (5) Prohibition against discrimination on the basis of health 
factors.
    (6) Additional requirements prohibiting discrimination based on 
genetic information.
    (c) Similar requirements under the Employee Retirement Income 
Security Act and the Public Health Service Act. Sections 701, 702, 703, 
711, 712, 732, and 733 of the Employee Retirement Income Security Act of 
1974 and sections 2701, 2702, 2704, 2705, 2721, and 2791 of the Public 
Health Service Act impose requirements similar to those imposed under 
Chapter 100 of Subtitle K with respect to health insurance issuers 
offering group health insurance coverage. See 29 CFR part 2590 and 45 
CFR parts 144, 146, and 148. See also part B of Title XXVII of the 
Public Health Service Act and 45 CFR part 148 for other rules applicable 
to health insurance offered in the individual market (defined in Sec. 
54.9801-2).

[T.D. 9166, 69 FR 78746, Dec. 30, 2004, as amended by T.D. 9299, 71 FR 
75056, Dec. 13, 2006; T.D. 9427, 73 FR 62419, Oct. 20, 2008; T.D. 9464, 
74 FR 51678, Oct. 7, 2009]



Sec. 54.9801-2  Definitions.

    Unless otherwise provided, the definitions in this section govern in 
applying the provisions of Sec. 54.9801-1, this section, Sec. Sec. 
54.9801-3 through 54.9801-6, 54.9802-1, 54.9802-2, 54.9802-3T, 54.9811-
1, 54.9812-1T, 54.9831-1, and 54.9833-1.
    Affiliation period means a period of time that must expire before 
health insurance coverage provided by an HMO becomes effective, and 
during which the HMO is not required to provide benefits.

[[Page 408]]

    COBRA definitions:
    (1) COBRA means Title X of the Consolidated Omnibus Budget 
Reconciliation Act of 1985, as amended.
    (2) COBRA continuation coverage means coverage, under a group health 
plan, that satisfies an applicable COBRA continuation provision.
    (3) COBRA continuation provision means section 4980B (other than 
paragraph (f)(1) of section 4980B insofar as it relates to pediatric 
vaccines), sections 601-608 of ERISA, or Title XXII of the PHS Act.
    (4) Exhaustion of COBRA continuation coverage means that an 
individual's COBRA continuation coverage ceases for any reason other 
than either failure of the individual to pay premiums on a timely basis, 
or for cause (such as making a fraudulent claim or an intentional 
misrepresentation of a material fact in connection with the plan). An 
individual is considered to have exhausted COBRA continuation coverage 
if such coverage ceases--
    (i) Due to the failure of the employer or other responsible entity 
to remit premiums on a timely basis;
    (ii) When the individual no longer resides, lives, or works in the 
service area of an HMO or similar program (whether or not within the 
choice of the individual) and there is no other COBRA continuation 
coverage available to the individual; or
    (iii) When the individual incurs a claim that would meet or exceed a 
lifetime limit on all benefits and there is no other COBRA continuation 
coverage available to the individual.
    Condition means a medical condition.
    Creditable coverage means creditable coverage within the meaning of 
Sec. 54.9801-4(a).
    Dependent means any individual who is or may become eligible for 
coverage under the terms of a group health plan because of a 
relationship to a participant.
    Employee Retirement Income Security Act of 1974 (ERISA) means the 
Employee Retirement Income Security Act of 1974, as amended (29 U.S.C. 
1001 et seq.).
    Enroll means to become covered for benefits under a group health 
plan (that is, when coverage becomes effective), without regard to when 
the individual may have completed or filed any forms that are required 
in order to become covered under the plan. For this purpose, an 
individual who has health coverage under a group health plan is enrolled 
in the plan regardless of whether the individual elects coverage, the 
individual is a dependent who becomes covered as a result of an election 
by a participant, or the individual becomes covered without an election.
    Enrollment date definitions (enrollment date, first day of coverage, 
and waiting period) are set forth in Sec. 54.9801-3(a)(3)(i), (ii), and 
(iii).
    Excepted benefits means the benefits described as excepted in Sec. 
54.9831(c).
    Genetic information has the meaning given the term in Sec. 54.9802-
3T(a)(3).
    Group health insurance coverage means health insurance coverage 
offered in connection with a group health plan.
    Group health plan or plan means a group health plan within the 
meaning of Sec. 54.9831-1(a).
    Group market means the market for health insurance coverage offered 
in connection with a group health plan. (However, certain very small 
plans may be treated as being in the individual market, rather than the 
group market; see the definition of individual market in this section.)
    Health insurance coverage means benefits consisting of medical care 
(provided directly, through insurance or reimbursement, or otherwise) 
under any hospital or medical service policy or certificate, hospital or 
medical service plan contract, or HMO contract offered by a health 
insurance issuer. Health insurance coverage includes group health 
insurance coverage, individual health insurance coverage, and short-
term, limited-duration insurance. However, benefits described in Sec. 
54.9831(c)(2) are not treated as benefits consisting of medical care.
    Health insurance issuer or issuer means an insurance company, 
insurance service, or insurance organization (including an HMO) that is 
required to be licensed to engage in the business of insurance in a 
State and that is subject to State law that regulates insurance (within 
the meaning of section 514(b)(2) of ERISA). Such term does not include a 
group health plan.

[[Page 409]]

    Health maintenance organization or HMO means--
    (1) A federally qualified health maintenance organization (as 
defined in section 1301(a) of the PHS Act);
    (2) An organization recognized under State law as a health 
maintenance organization; or
    (3) A similar organization regulated under State law for solvency in 
the same manner and to the same extent as such a health maintenance 
organization.
    Individual health insurance coverage means health insurance coverage 
offered to individuals in the individual market, but does not include 
short-term, limited-duration insurance. Individual health insurance 
coverage can include dependent coverage.
    Individual market means the market for health insurance coverage 
offered to individuals other than in connection with a group health 
plan. Unless a State elects otherwise in accordance with section 
2791(e)(1)(B)(ii) of the PHS Act, such term also includes coverage 
offered in connection with a group health plan that has fewer than two 
participants who are current employees on the first day of the plan 
year.
    Issuer means a health insurance issuer.
    Late enrollment definitions (late enrollee and late enrollment) are 
set forth in Sec. 54.9801-3(a)(3)(v) and (vi) .
    Medical care has the meaning given such term by section 213(d), 
determined without regard to section 213(d)(1)(C) and so much of section 
213(d)(1)(D) as relates to qualified long-term care insurance.
    Medical condition or condition means any condition, whether physical 
or mental, including, but not limited to, any condition resulting from 
illness, injury (whether or not the injury is accidental), pregnancy, or 
congenital malformation. However, genetic information is not a 
condition.
    Participant means participant within the meaning of section 3(7) of 
ERISA.
    Placement, or being placed, for adoption means the assumption and 
retention of a legal obligation for total or partial support of a child 
by a person with whom the child has been placed in anticipation of the 
child's adoption. The child's placement for adoption with such person 
ends upon the termination of such legal obligation.
    Plan year means the year that is designated as the plan year in the 
plan document of a group health plan, except that if the plan document 
does not designate a plan year or if there is no plan document, the plan 
year is--
    (1) The deductible or limit year used under the plan;
    (2) If the plan does not impose deductibles or limits on a yearly 
basis, then the plan year is the policy year;
    (3) If the plan does not impose deductibles or limits on a yearly 
basis, and either the plan is not insured or the insurance policy is not 
renewed on an annual basis, then the plan year is the employer's taxable 
year; or
    (4) In any other case, the plan year is the calendar year.
    Preexisting condition exclusion means a limitation or exclusion of 
benefits (including a denial of coverage) based on the fact that the 
condition was present before the effective date of coverage (or if 
coverage is denied, the date of the denial) under a group health plan or 
group or individual health insurance coverage (or other coverage 
provided to federally eligible individuals pursuant to 45 CFR part 148), 
whether or not any medical advice, diagnosis, care, or treatment was 
recommended or received before that day. A preexisting condition 
exclusion includes any limitation or exclusion of benefits (including a 
denial of coverage) applicable to an individual as a result of 
information relating to an individual's health status before the 
individual's effective date of coverage (or if coverage is denied, the 
date of the denial) under a group health plan, or group or individual 
health insurance coverage (or other coverage provided to Federally 
eligible individuals pursuant to 45 CFR part 148), such as a condition 
identified as a result of a pre-enrollment questionnaire or physical 
examination given to the individual, or review of medical records 
relating to the pre-enrollment period.
    Public health plan means public health plan within the meaning of 
Sec. 54.9801-4(a)(1)(ix).
    Public Health Service Act (PHS Act) means the Public Health Service 
Act (42 U.S.C. 201, et seq.).

[[Page 410]]

    Short-term, limited-duration insurance means health insurance 
coverage provided pursuant to a contract with an issuer that has an 
expiration date specified in the contract (taking into account any 
extensions that may be elected by the policyholder without the issuer's 
consent) that is less than 12 months after the original effective date 
of the contract.
    Significant break in coverage means a significant break in coverage 
within the meaning of Sec. 54.9801-4(b)(2)(iii).
    Special enrollment means enrollment in a group health plan under the 
rights described in Sec. 54.9801-6 or in group health insurance 
coverage under the rights described in 29 CFR 2590.701-6 or 45 CFR 
146.117.
    State health benefits risk pool means a State health benefits risk 
pool within the meaning of Sec. 54.9801-4(a)(1)(vii).
    Waiting period means waiting period within the meaning of Sec. 
54.9801-3(a)(3)(iii).

[T.D. 9166, 69 FR 78746, Dec. 30, 2004, as amended by T.D. 9299, 71 FR 
75056, Dec. 13, 2006; T.D. 9427, 73 FR 62420, Oct. 20, 2008; T.D. 9464, 
74 FR 51678, Oct. 7, 2009; T.D. 9491, 75 FR 37222, June 28, 2010]



Sec. 54.9801-3  Limitations on preexisting condition exclusion period.

    (a) Preexisting condition exclusion--(1) Defined--(i) A preexisting 
condition exclusion means a preexisting condition exclusion within the 
meaning set forth in Sec. 54.9801-2.
    (ii) Examples. The rules of this paragraph (a)(1) are illustrated by 
the following examples:

    Example 1. (i) Facts. A group health plan provides benefits solely 
through an insurance policy offered by Issuer S. At the expiration of 
the policy, the plan switches coverage to a policy offered by Issuer T. 
Issuer T's policy excludes benefits for any prosthesis if the body part 
was lost before the effective date of coverage under the policy.
    (ii) Conclusion. In this Example 1, the exclusion of benefits for 
any prosthesis if the body part was lost before the effective date of 
coverage is a preexisting condition exclusion because it operates to 
exclude benefits for a condition based on the fact that the condition 
was present before the effective date of coverage under the policy. 
(Therefore, the exclusion of benefits is required to comply with the 
limitations on preexisting condition exclusions in this section. For an 
example illustrating the application of these limitations to a 
succeeding insurance policy, see Example 3 of paragraph (a)(3)(iv) of 
this section.)
    Example 2. (i) Facts. A group health plan provides coverage for 
cosmetic surgery in cases of accidental injury, but only if the injury 
occurred while the individual was covered under the plan.
    (ii) Conclusion. In this Example 2, the plan provision excluding 
cosmetic surgery benefits for individuals injured before enrolling in 
the plan is a preexisting condition exclusion because it operates to 
exclude benefits relating to a condition based on the fact that the 
condition was present before the effective date of coverage. The plan 
provision, therefore, is subject to the limitations on preexisting 
condition exclusions in this section.
    Example 3. (i) Facts. A group health plan provides coverage for the 
treatment of diabetes, generally not subject to any lifetime dollar 
limit. However, if an individual was diagnosed with diabetes before the 
effective date of coverage under the plan, diabetes coverage is subject 
to a lifetime limit of $10,000.
    (ii) Conclusion. In this Example 3, the $10,000 lifetime limit is a 
preexisting condition exclusion because it limits benefits for a 
condition based on the fact that the condition was present before the 
effective date of coverage. The plan provision, therefore, is subject to 
the limitations on preexisting condition exclusions in this section.
    Example 4. (i) Facts. A group health plan provides coverage for the 
treatment of acne, subject to a lifetime limit of $2,000. The plan 
counts against this $2,000 lifetime limit on acne treatment benefits 
provided under prior health coverage.
    (ii) Conclusion. In this Example 4, counting benefits for a specific 
condition provided under prior health coverage against a lifetime limit 
for that condition is a preexisting condition exclusion because it 
operates to limit benefits for a condition based on the fact that the 
condition was present before the effective date of coverage. The plan 
provision, therefore, is subject to the limitations on preexisting 
condition exclusions in this section.
    Example 5. (i) Facts. When an individual's coverage begins under a 
group health plan, the individual generally becomes eligible for all 
benefits. However, benefits for pregnancy are not available until the 
individual has been covered under the plan for 12 months.
    (ii) Conclusion. In this Example 5, the requirement to be covered 
under the plan for 12 months to be eligible for pregnancy benefits is a 
subterfuge for a preexisting condition exclusion because it is designed 
to exclude benefits for a condition (pregnancy) that arose before the 
effective date of coverage. Because a plan is prohibited under paragraph

[[Page 411]]

(b)(5) of this section from imposing any preexisting condition exclusion 
on pregnancy, the plan provision is prohibited. However, if the plan 
provision included an exception for women who were pregnant before the 
effective date of coverage under the plan (so that the provision applied 
only to women who became pregnant on or after the effective date of 
coverage) the plan provision would not be a preexisting condition 
exclusion (and would not be prohibited by paragraph (b)(5) of this 
section).
    Example 6. (i) Facts. A group health plan provides coverage for 
medically necessary items and services, generally including treatment of 
heart conditions. However, the plan does not cover those same items and 
services when used for treatment of congenital heart conditions.
    (ii) Conclusion. In this Example 6, the exclusion of coverage for 
treatment of congenital heart conditions is a preexisting condition 
exclusion because it operates to exclude benefits relating to a 
condition based on the fact that the condition was present before the 
effective date of coverage. The plan provision, therefore, is subject to 
the limitations on preexisting condition exclusions in this section.
    Example 7. (i) Facts. A group health plan generally provides 
coverage for medically necessary items and services. However, the plan 
excludes coverage for the treatment of cleft palate.
    (ii) Conclusion. In this Example 7, the exclusion of coverage for 
treatment of cleft palate is not a preexisting condition exclusion 
because the exclusion applies regardless of when the condition arose 
relative to the effective date of coverage. The plan provision, 
therefore, is not subject to the limitations on preexisting condition 
exclusions in this section.
    Example 8. (i) Facts. A group health plan provides coverage for 
treatment of cleft palate, but only if the individual being treated has 
been continuously covered under the plan from the date of birth.
    (ii) Conclusion. In this Example 8, the exclusion of coverage for 
treatment of cleft palate for individuals who have not been covered 
under the plan from the date of birth operates to exclude benefits in 
relation to a condition based on the fact that the condition was present 
before the effective date of coverage. The plan provision, therefore, is 
subject to the limitations on preexisting condition exclusions in this 
section.

    (2) General rules. Subject to paragraph (b) of this section 
(prohibiting the imposition of a preexisting condition exclusion with 
respect to certain individuals and conditions), a group health plan may 
impose, with respect to a participant or beneficiary, a preexisting 
condition exclusion only if the requirements of this paragraph (a)(2) 
are satisfied. (See section 701 of ERISA and section 2701 of the PHS 
Act, under which these requirements are also imposed on a health 
insurance issuer offering group health insurance coverage.)
    (i) 6-month look-back rule. A preexisting condition exclusion must 
relate to a condition (whether physical or mental), regardless of the 
cause of the condition, for which medical advice, diagnosis, care, or 
treatment was recommended or received within the 6-month period (or such 
shorter period as applies under the plan) ending on the enrollment date.
    (A) For purposes of this paragraph (a)(2)(i), medical advice, 
diagnosis, care, or treatment is taken into account only if it is 
recommended by, or received from, an individual licensed or similarly 
authorized to provide such services under State law and operating within 
the scope of practice authorized by State law.
    (B) For purposes of this paragraph (a)(2)(i), the 6-month period 
ending on the enrollment date begins on the 6-month anniversary date 
preceding the enrollment date. For example, for an enrollment date of 
August 1, 1998, the 6-month period preceding the enrollment date is the 
period commencing on February 1, 1998 and continuing through July 31, 
1998. As another example, for an enrollment date of August 30, 1998, the 
6-month period preceding the enrollment date is the period commencing on 
February 28, 1998 and continuing through August 29, 1998.
    (C) The rules of this paragraph (a)(2)(i) are illustrated by the 
following examples:

    Example 1. (i) Facts. Individual A is diagnosed with a medical 
condition 8 months before A's enrollment date in Employer R's group 
health plan. A's doctor recommends that A take a prescription drug for 3 
months, and A follows the recommendation.
    (ii) Conclusion. In this Example 1, Employer R's plan may impose a 
preexisting condition exclusion with respect to A's condition because A 
received treatment during the 6-month period ending on A's enrollment 
date in Employer R's plan by taking the prescription medication during 
that period. However, if A did not take the prescription drug during the 
6-month period, Employer R's plan

[[Page 412]]

would not be able to impose a preexisting condition exclusion with 
respect to that condition.
    Example 2. (i) Facts. Individual B is treated for a medical 
condition 7 months before the enrollment date in Employer S's group 
health plan. As part of such treatment, B's physician recommends that a 
follow-up examination be given 2 months later. Despite this 
recommendation, B does not receive a follow-up examination, and no other 
medical advice, diagnosis, care, or treatment for that condition is 
recommended to B or received by B during the 6-month period ending on 
B's enrollment date in Employer S's plan.
    (ii) Conclusion. In this Example 2, Employer S's plan may not impose 
a preexisting condition exclusion with respect to the condition for 
which B received treatment 7 months prior to the enrollment date.
    Example 3. (i) Facts. Same facts as Example 2, except that Employer 
S's plan learns of the condition and attaches a rider to B's certificate 
of coverage excluding coverage for the condition. Three months after 
enrollment, B's condition recurs, and Employer S's plan denies payment 
under the rider.
    (ii) Conclusion. In this Example 3, the rider is a preexisting 
condition exclusion and Employer S's plan may not impose a preexisting 
condition exclusion with respect to the condition for which B received 
treatment 7 months prior to the enrollment date. (In addition, such a 
rider would violate the provisions of Sec. 54.9802-1, even if B had 
received treatment for the condition within the 6-month period ending on 
the enrollment date.)
    Example 4. (i) Facts. Individual C has asthma and is treated for 
that condition several times during the 6-month period before C's 
enrollment date in Employer T's plan. Three months after the enrollment 
date, C begins coverage under Employer T's plan. Two months later, C is 
hospitalized for asthma.
    (ii) Conclusion. In this Example 4, Employer T's plan may impose a 
preexisting condition exclusion with respect to C's asthma because care 
relating to C's asthma was received during the 6-month period ending on 
C's enrollment date (which, under the rules of paragraph (a)(3)(i) of 
this section, is the first day of the waiting period).
    Example 5. (i) Facts. Individual D, who is subject to a preexisting 
condition exclusion imposed by Employer U's plan, has diabetes, as well 
as retinal degeneration, a foot condition, and poor circulation (all of 
which are conditions that may be directly attributed to diabetes). D 
receives treatment for these conditions during the 6-month period ending 
on D's enrollment date in Employer U's plan. After enrolling in the 
plan, D stumbles and breaks a leg.
    (ii) Conclusion. In this Example 5, the leg fracture is not a 
condition related to D's diabetes, retinal degeneration, foot condition, 
or poor circulation, even though they may have contributed to the 
accident. Therefore, benefits to treat the leg fracture cannot be 
subject to a preexisting condition exclusion. However, any additional 
medical services that may be needed because of D's preexisting diabetes, 
poor circulation, or retinal degeneration that would not be needed by 
another patient with a broken leg who does not have these conditions may 
be subject to the preexisting condition exclusion imposed under Employer 
U's plan.

    (ii) Maximum length of preexisting condition exclusion. A 
preexisting condition exclusion is not permitted to extend for more than 
12 months (18 months in the case of a late enrollee) after the 
enrollment date. For example, for an enrollment date of August 1, 1998, 
the 12-month period after the enrollment date is the period commencing 
on August 1, 1998 and continuing through July 31, 1999; the 18-month 
period after the enrollment date is the period commencing on August 1, 
1998 and continuing through January 31, 2000.
    (iii) Reducing a preexisting condition exclusion period by 
creditable coverage--(A) The period of any preexisting condition 
exclusion that would otherwise apply to an individual under a group 
health plan is reduced by the number of days of creditable coverage the 
individual has as of the enrollment date, as counted under Sec. 
54.9801-4. Creditable coverage may be evidenced through a certificate of 
creditable coverage (required under Sec. 54.9801-5(a)), or through 
other means in accordance with the rules of Sec. 54.9801-5(c).
    (B) The rules of this paragraph (a)(2)(iii) are illustrated by the 
following example:

    Example. (i) Facts. Individual D works for Employer X and has been 
covered continuously under X's group health plan. D's spouse works for 
Employer Y. Y maintains a group health plan that imposes a 12-month 
preexisting condition exclusion (reduced by creditable coverage) on all 
new enrollees. D enrolls in Y's plan, but also stays covered under X's 
plan. D presents Y's plan with evidence of creditable coverage under X's 
plan.
    (ii) Conclusion. In this Example, Y's plan must reduce the 
preexisting condition exclusion period that applies to D by the number 
of days of coverage that D had under X's plan as of D's enrollment date 
in Y's plan (even though D's coverage under X's plan was continuing as 
of that date).


[[Page 413]]


    (iv) Other standards. See Sec. 54.9802-1 for other standards that 
may apply with respect to certain benefit limitations or restrictions 
under a group health plan. Other laws may also apply, such as the 
Uniformed Services Employment and Reemployment Rights Act (USERRA), 
which can affect the application of a preexisting condition exclusion to 
certain individuals who are reinstated in a group health plan following 
active military service.
    (3) Enrollment definitions--(i) Enrollment date means the first day 
of coverage (as described in paragraph (a)(3)(ii) of this section) or, 
if there is a waiting period, the first day of the waiting period. If an 
individual receiving benefits under a group health plan changes benefit 
packages, or if the plan changes group health insurance issuers, the 
individual's enrollment date does not change.
    (ii) First day of coverage means, in the case of an individual 
covered for benefits under a group health plan, the first day of 
coverage under the plan and, in the case of an individual covered by 
health insurance coverage in the individual market, the first day of 
coverage under the policy or contract.
    (iii) Waiting period means the period that must pass before coverage 
for an employee or dependent who is otherwise eligible to enroll under 
the terms of a group health plan can become effective. If an employee or 
dependent enrolls as a late enrollee or special enrollee, any period 
before such late or special enrollment is not a waiting period. If an 
individual seeks coverage in the individual market, a waiting period 
begins on the date the individual submits a substantially complete 
application for coverage and ends on--
    (A) If the application results in coverage, the date coverage 
begins;
    (B) If the application does not result in coverage, the date on 
which the application is denied by the issuer or the date on which the 
offer of coverage lapses.
    (iv) The rules of paragraphs (a)(3)(i), (ii), and (iii) of this 
section are illustrated by the following examples:

    Example 1. (i) Facts. Employer V's group health plan provides for 
coverage to begin on the first day of the first payroll period following 
the date an employee is hired and completes the applicable enrollment 
forms, or on any subsequent January 1 after completion of the applicable 
enrollment forms. Employer V's plan imposes a preexisting condition 
exclusion for 12 months (reduced by the individual's creditable 
coverage) following an individual's enrollment date. Employee E is hired 
by Employer V on October 13, 1998, and on October 14, 1998 E completes 
and files all the forms necessary to enroll in the plan. E's coverage 
under the plan becomes effective on October 25, 1998 (which is the 
beginning of the first payroll period after E's date of hire).
    (ii) Conclusion. In this Example 1, E's enrollment date is October 
13, 1998 (which is the first day of the waiting period for E's 
enrollment and is also E's date of hire). Accordingly, with respect to 
E, the permissible 6-month period in paragraph (a)(2)(i) is the period 
from April 13, 1998 through October 12, 1998, the maximum permissible 
period during which Employer V's plan can apply a preexisting condition 
exclusion under paragraph (a)(2)(ii) is the period from October 13, 1998 
through October 12, 1999, and this period must be reduced under 
paragraph (a)(2)(iii) by E's days of creditable coverage as of October 
13, 1998.
    Example 2. (i) Facts. A group health plan has two benefit package 
options, Option 1 and Option 2. Under each option a 12-month preexisting 
condition exclusion is imposed. Individual B is enrolled in Option 1 on 
the first day of employment with the employer maintaining the plan, 
remains enrolled in Option 1 for more than one year, and then decides to 
switch to Option 2 at open season.
    (ii) Conclusion. In this Example 2, B cannot be subject to any 
preexisting condition exclusion under Option 2 because any preexisting 
condition exclusion period would have to begin on B's enrollment date, 
which is B's first day of coverage, rather than the date that B enrolled 
in Option 2. Therefore, the preexisting condition exclusion period 
expired before B switched to Option 2.
    Example 3. (i) Facts. On May 13, 1997, Individual E is hired by an 
employer and enrolls in the employer's group health plan. The plan 
provides benefits solely through an insurance policy offered by Issuer 
S. On December 27, 1998, E's leg is injured in an accident and the leg 
is amputated. On January 1, 1999, the plan switches coverage to a policy 
offered by Issuer T. Issuer T's policy excludes benefits for any 
prosthesis if the body part was lost before the effective date of 
coverage under the policy.
    (ii) Conclusion. In this Example 3, E's enrollment date is May 13, 
1997, E's first day of coverage. Therefore, the permissible 6-month 
look-back period for the preexisting condition exclusion imposed under 
Issuer T's policy begins on November 13, 1996 and ends on

[[Page 414]]

May 12, 1997. In addition, the 12-month maximum permissible preexisting 
condition exclusion period begins on May 13, 1997 and ends on May 12, 
1998. Accordingly, because no medical advice, diagnosis, care, or 
treatment was recommended to or received by E for the leg during the 6-
month look-back period (even though medical care was provided within the 
6-month period preceding the effective date of E's coverage under Issuer 
T's policy), the plan may not impose any preexisting condition exclusion 
with respect to E. Moreover, even if E had received treatment during the 
6-month look-back period, the plan still would not be permitted to 
impose a preexisting condition exclusion because the 12-month maximum 
permissible preexisting condition exclusion period expired on May 12, 
1998 (before the effective date of E's coverage under Issuer T's 
policy). See 29 CFR 2590.701-3(a)(3)(iv) Example 3 and 45 CFR 
146.111(a)(3)(iv) Example 3 for a conclusion that Issuer T is similarly 
prohibited from imposing a preexisting condition exclusion with respect 
to E.
    Example 4. (i) Facts. A group health plan limits eligibility for 
coverage to full-time employees of Employer Y. Coverage becomes 
effective on the first day of the month following the date the employee 
becomes eligible. Employee C begins working full-time for Employer Y on 
April 11. Prior to this date, C worked part-time for Y. C enrolls in the 
plan and coverage is effective May 1.
    (ii) Conclusion. In this Example 4, C's enrollment date is April 11 
and the period from April 11 through April 30 is a waiting period. The 
period while C was working part-time, and therefore not in an eligible 
class of employees, is not part of the waiting period.
    Example 5. (i) Facts. To be eligible for coverage under a 
multiemployer group health plan in the current calendar quarter, the 
plan requires an individual to have worked 250 hours in covered 
employment during the previous quarter. If the hours requirement is 
satisfied, coverage becomes effective on the first day of the current 
calendar quarter. Employee D begins work on January 28 and does not work 
250 hours in covered employment during the first quarter (ending March 
31). D works at least 250 hours in the second quarter (ending June 30) 
and is enrolled in the plan with coverage effective July 1 (the first 
day of the third quarter).
    (ii) Conclusion. In this Example 5, D's enrollment date is the first 
day of the quarter during which D satisfies the hours requirement, which 
is April 1. The period from April 1 through June 30 is a waiting period.

    (v) Late enrollee means an individual whose enrollment in a plan is 
a late enrollment.
    (vi) (A) Late enrollment means enrollment of an individual under a 
group health plan other than--
    (1) On the earliest date on which coverage can become effective for 
the individual under the terms of the plan; or
    (2) Through special enrollment. (For rules relating to special 
enrollment, see Sec. 54.9801-6.)
    (B) If an individual ceases to be eligible for coverage under the 
plan, and then subsequently becomes eligible for coverage under the 
plan, only the individual's most recent period of eligibility is taken 
into account in determining whether the individual is a late enrollee 
under the plan with respect to the most recent period of coverage. 
Similar rules apply if an individual again becomes eligible for coverage 
following a suspension of coverage that applied generally under the 
plan.
    (vii) Examples. The rules of paragraphs (a)(3)(v) and (vi) of this 
section are illustrated by the following examples:

    Example 1. (i) Facts. Employee F first becomes eligible to be 
covered by Employer W's group health plan on January 1, 1999 but elects 
not to enroll in the plan until a later annual open enrollment period, 
with coverage effective January 1, 2001. F has no special enrollment 
right at that time.
    (ii) Conclusion. In this Example 1, F is a late enrollee with 
respect to F's coverage that became effective under the plan on January 
1, 2001.
    Example 2. (i) Facts. Same facts as Example 1, except that F 
terminates employment with Employer W on July 1, 1999 without having had 
any health insurance coverage under the plan. F is rehired by Employer W 
on January 1, 2000 and is eligible for and elects coverage under 
Employer W's plan effective on January 1, 2000.
    (ii) Conclusion. In this Example 2, F would not be a late enrollee 
with respect to F's coverage that became effective on January 1, 2000.

    (b) Exceptions pertaining to preexisting condition exclusions--(1) 
Newborns--(i) In general. Subject to paragraph (b)(3) of this section, a 
group health plan may not impose any preexisting condition exclusion on 
a child who, within 30 days after birth, is covered under any creditable 
coverage. Accordingly, if a child is enrolled in a group health plan (or 
other creditable coverage) within 30 days after birth and subsequently 
enrolls in another group health plan without a significant break in 
coverage (as described in Sec. 54.9801-4(b)(2)(iii)), the

[[Page 415]]

other plan may not impose any preexisting condition exclusion on the 
child.
    (ii) Examples. The rules of this paragraph (b)(1) are illustrated by 
the following examples:

    Example 1. (i) Facts. Individual E, who has no prior creditable 
coverage, begins working for Employer W and has accumulated 210 days of 
creditable coverage under Employer W's group health plan on the date E 
gives birth to a child. Within 30 days after the birth, the child is 
enrolled in the plan. Ninety days after the birth, both E and the child 
terminate coverage under the plan. Both E and the child then experience 
a break in coverage of 45 days before E is hired by Employer X and the 
two are enrolled in Employer X's group health plan.
    (ii) Conclusion. In this Example 1, because E's child is enrolled in 
Employer W's plan within 30 days after birth, no preexisting condition 
exclusion may be imposed with respect to the child under Employer W's 
plan. Likewise, Employer X's plan may not impose any preexisting 
condition exclusion on E's child because the child was covered under 
creditable coverage within 30 days after birth and had no significant 
break in coverage before enrolling in Employer X's plan. On the other 
hand, because E had only 300 days of creditable coverage prior to E's 
enrollment date in Employer X's plan, Employer X's plan may impose a 
preexisting condition exclusion on E for up to 65 days (66 days if the 
12-month period after E's enrollment date in X's plan includes February 
29).
    Example 2. (i) Facts. Individual F is enrolled in a group health 
plan in which coverage is provided through a health insurance issuer. F 
gives birth. Under State law applicable to the health insurance issuer, 
health care expenses incurred for the child during the 30 days following 
birth are covered as part of F's coverage. Although F may obtain 
coverage for the child beyond 30 days by timely requesting special 
enrollment and paying an additional premium, the issuer is prohibited 
under State law from recouping the cost of any expenses incurred for the 
child within the 30-day period if the child is not later enrolled.
    (ii) Conclusion. In this Example 2, the child is covered under 
creditable coverage within 30 days after birth, regardless of whether 
the child enrolls as a special enrollee under the plan. Therefore, no 
preexisting condition exclusion may be imposed on the child unless the 
child has a significant break in coverage.

    (2) Adopted children. Subject to paragraph (b)(3) of this section, a 
group health plan may not impose any preexisting condition exclusion on 
a child who is adopted or placed for adoption before attaining 18 years 
of age and who, within 30 days after the adoption or placement for 
adoption, is covered under any creditable coverage. Accordingly, if a 
child is enrolled in a group health plan (or other creditable coverage) 
within 30 days after adoption or placement for adoption and subsequently 
enrolls in another group health plan without a significant break in 
coverage (as described in Sec. 54.9801-4(b)(2)(iii)), the other plan 
may not impose any preexisting condition exclusion on the child. This 
rule does not apply to coverage before the date of such adoption or 
placement for adoption.
    (3) Significant break in coverage. Paragraphs (b)(1) and (2) of this 
section no longer apply to a child after a significant break in 
coverage. (See Sec. 54.9801-4(b)(2)(iii) for rules relating to the 
determination of a significant break in coverage.)
    (4) Special enrollment. For special enrollment rules relating to new 
dependents, see Sec. 54.9801-6(b).
    (5) Pregnancy. A group health plan may not impose a preexisting 
condition exclusion relating to pregnancy.
    (6) Genetic information--(i) A group health plan may not impose a 
preexisting condition exclusion relating to a condition based solely on 
genetic information. However, if an individual is diagnosed with a 
condition, even if the condition relates to genetic information, the 
plan may impose a preexisting condition exclusion with respect to the 
condition, subject to the other limitations of this section.
    (ii) The rules of this paragraph (b)(6) are illustrated by the 
following example:

    Example. (i) Facts. Individual A enrolls in a group health plan that 
imposes a 12-month maximum preexisting condition exclusion. Three months 
before A's enrollment, A's doctor told A that, based on genetic 
information, A has a predisposition towards breast cancer. A was not 
diagnosed with breast cancer at any time prior to A's enrollment date in 
the plan. Nine months after A's enrollment date in the plan, A is 
diagnosed with breast cancer.
    (ii) Conclusion. In this Example, the plan may not impose a 
preexisting condition exclusion with respect to A's breast cancer 
because, prior to A's enrollment date, A was not diagnosed with breast 
cancer.


[[Page 416]]


    (c) General notice of preexisting condition exclusion. A group 
health plan imposing a preexisting condition exclusion must provide a 
written general notice of preexisting condition exclusion to 
participants under the plan and cannot impose a preexisting condition 
exclusion with respect to a participant or a dependent of the 
participant until such a notice is provided. (See 29 CFR 2590.701-3(c) 
and 45 CFR 146.111(c), which also impose this requirement on a health 
insurance issuer offering group health insurance coverage subject to a 
preexisting condition exclusion.)
    (1) Manner and timing. A plan must provide the general notice of 
preexisting condition exclusion as part of any written application 
materials distributed by the plan for enrollment. If the plan does not 
distribute such materials, the notice must be provided by the earliest 
date following a request for enrollment that the plan, acting in a 
reasonable and prompt fashion, can provide the notice.
    (2) Content. The general notice of preexisting condition exclusion 
must notify participants of the following:
    (i) The existence and terms of any preexisting condition exclusion 
under the plan. This description includes the length of the plan's look-
back period (which is not to exceed 6 months under paragraph (a)(2)(i) 
of this section); the maximum preexisting condition exclusion period 
under the plan (which cannot exceed 12 months (or 18 months for late 
enrollees) under paragraph (a)(2)(ii) of this section); and how the plan 
will reduce the maximum preexisting condition exclusion period by 
creditable coverage (described in paragraph (a)(2)(iii) of this 
section).
    (ii) A description of the rights of individuals to demonstrate 
creditable coverage, and any applicable waiting periods, through a 
certificate of creditable coverage (as required by Sec. 54.9801-5(a)) 
or through other means (as described in Sec. 54.9801-5(c)). This must 
include a description of the right of the individual to request a 
certificate from a prior plan or issuer, if necessary, and a statement 
that the current plan will assist in obtaining a certificate from any 
prior plan or issuer, if necessary.
    (iii) A person to contact (including an address or telephone number) 
for obtaining additional information or assistance regarding the 
preexisting condition exclusion.
    (3) Duplicate notices not required. If a notice satisfying the 
requirements of this paragraph (c) is provided to an individual by 
another party, the plan's obligation to provide a general notice of 
preexisting condition exclusion with respect to that individual is 
satisfied. (See 29 CFR 2590.701-3(c)(3) and 45 CFR 146.111(c)(3), which 
provide that the issuer's obligation is similarly satisfied.)
    (4) Example with sample language. The rules of this paragraph (c) 
are illustrated by the following example, which includes sample language 
that plans can use as a basis for preparing their own notices to satisfy 
the requirements of this paragraph (c):

    Example. (i) Facts. A group health plan makes coverage effective on 
the first day of the first calendar month after hire and on each January 
1 following an open season. The plan imposes a 12-month maximum 
preexisting condition exclusion (18 months for late enrollees) and uses 
a 6-month look-back period. As part of the enrollment application 
materials, the plan provides the following statement:
    This plan imposes a preexisting condition exclusion. This means that 
if you have a medical condition before coming to our plan, you might 
have to wait a certain period of time before the plan will provide 
coverage for that condition. This exclusion applies only to conditions 
for which medical advice, diagnosis, care, or treatment was recommended 
or received within a six-month period. Generally, this six-month period 
ends the day before your coverage becomes effective. However, if you 
were in a waiting period for coverage, the six-month period ends on the 
day before the waiting period begins. The preexisting condition 
exclusion does not apply to pregnancy nor to a child who is enrolled in 
the plan within 30 days after birth, adoption, or placement for 
adoption.
    This exclusion may last up to 12 months (18 months if you are a late 
enrollee) from your first day of coverage, or, if you were in a waiting 
period, from the first day of your waiting period. However, you can 
reduce the length of this exclusion period by the number of days of your 
prior ``creditable coverage.'' Most prior health coverage is creditable 
coverage and can be used to reduce the preexisting condition exclusion 
if you have not experienced a break in coverage of at least 63 days. To 
reduce the 12-month (or 18-

[[Page 417]]

month) exclusion period by your creditable coverage, you should give us 
a copy of any certificates of creditable coverage you have. If you do 
not have a certificate, but you do have prior health coverage, we will 
help you obtain one from your prior plan or issuer. There are also other 
ways that you can show you have creditable coverage. Please contact us 
if you need help demonstrating creditable coverage.
    All questions about the preexisting condition exclusion and 
creditable coverage should be directed to Individual B at Address M or 
Telephone Number N.
    (ii) Conclusion. In this Example, the plan satisfies the general 
notice requirement of this paragraph (c).

    (d) Determination of creditable coverage--(1) Determination within 
reasonable time. If a group health plan receives creditable coverage 
information under Sec. 54.9801-5, the plan is required, within a 
reasonable time following receipt of the information, to make a 
determination regarding the amount of the individual's creditable 
coverage and the length of any exclusion that remains. Whether this 
determination is made within a reasonable time depends on the relevant 
facts and circumstances. Relevant facts and circumstances include 
whether a plan's application of a preexisting condition exclusion would 
prevent an individual from having access to urgent medical care. (See 29 
CFR 2590.701-3(d) and 45 CFR 146.111(d), which also impose this 
requirement on a health insurance issuer offering group health insurance 
coverage.)
    (2) No time limit on presenting evidence of creditable coverage. A 
plan may not impose any limit on the amount of time that an individual 
has to present a certificate or other evidence of creditable coverage.
    (3) Example. The rules of this paragraph (d) are illustrated by the 
following example:

    Example. (i) Facts. A group health plan imposes a preexisting 
condition exclusion period of 12 months. After receiving the general 
notice of preexisting condition exclusion, Individual H develops an 
urgent health condition before receiving a certificate of creditable 
coverage from H's prior group health plan. H attests to the period of 
prior coverage, presents corroborating documentation of the coverage 
period, and authorizes the plan to request a certificate on H's behalf 
in accordance with the rules of Sec. 54.9801-5.
    (ii) Conclusion. In this Example, the plan must review the evidence 
presented by H and make a determination of creditable coverage within a 
reasonable time that is consistent with the urgency of H's health 
condition. (This determination may be modified as permitted under 
paragraph (f) of this section.)

    (e) Individual notice of period of preexisting condition exclusion. 
After an individual has presented evidence of creditable coverage and 
after the plan has made a determination of creditable coverage under 
paragraph (d) of this section, the plan must provide the individual a 
written notice of the length of preexisting condition exclusion that 
remains after offsetting for prior creditable coverage. This individual 
notice is not required to identify any medical conditions specific to 
the individual that could be subject to the exclusion. A plan is not 
required to provide this notice if the plan does not impose any 
preexisting condition exclusion on the individual or if the plan's 
preexisting condition exclusion is completely offset by the individual's 
prior creditable coverage. (See 29 CFR 2590.701-3(e) and 45 CFR 
146.111(e), which also impose this requirement on a health insurance 
issuer offering group health insurance coverage.)
    (1) Manner and timing. The individual notice must be provided by the 
earliest date following a determination that the plan, acting in a 
reasonable and prompt fashion, can provide the notice.
    (2) Content. A plan must disclose--
    (i) Its determination of any preexisting condition exclusion period 
that applies to the individual (including the last day on which the 
preexisting condition exclusion applies);
    (ii) The basis for such determination, including the source and 
substance of any information on which the plan relied;
    (iii) An explanation of the individual's right to submit additional 
evidence of creditable coverage; and
    (iv) A description of any applicable appeal procedures established 
by the plan.
    (3) Duplicate notices not required. If a notice satisfying the 
requirements of this paragraph (e) is provided to an individual by 
another party, the plan's obligation to provide this individual notice 
of preexisting condition exclusion with respect to that individual is

[[Page 418]]

satisfied. (See 29 CFR 2590.701-3(e)(3) and 45 CFR 146.111(e)(3), which 
provide that the issuer's obligation is similarly satisfied.)
    (4) Examples. The rules of this paragraph (e) are illustrated by the 
following examples:

    Example 1. (i) Facts. A group health plan imposes a preexisting 
condition exclusion period of 12 months. After receiving the general 
notice of preexisting condition exclusion, Individual G presents a 
certificate of creditable coverage indicating 240 days of creditable 
coverage. Within seven days of receipt of the certificate, the plan 
determines that G is subject to a preexisting condition exclusion of 125 
days, the last day of which is March 5. Five days later, the plan 
notifies G that, based on the certificate G submitted, G is subject to a 
preexisting condition exclusion period of 125 days, ending on March 5. 
The notice also explains the opportunity to submit additional evidence 
of creditable coverage and the plan's appeal procedures. The notice does 
not identify any of G's medical conditions that could be subject to the 
exclusion.
    (ii) Conclusion. In this Example 1, the plan satisfies the 
requirements of this paragraph (e).
    Example 2. (i) Facts. Same facts as in Example 1, except that the 
plan determines that G has 430 days of creditable coverage based on G's 
certificate indicating 430 days of creditable coverage under G's prior 
plan.
    (ii) Conclusion. In this Example 2, the plan is not required to 
notify G that G will not be subject to a preexisting condition 
exclusion.

    (f) Reconsideration. Nothing in this section prevents a plan from 
modifying an initial determination of creditable coverage if it 
determines that the individual did not have the claimed creditable 
coverage, provided that--
    (1) A notice of the new determination (consistent with the 
requirements of paragraph (e) of this section) is provided to the 
individual; and
    (2) Until the notice of the new determination is provided, the plan, 
for purposes of approving access to medical services (such as a pre-
surgery authorization), acts in a manner consistent with the initial 
determination.

[T.D. 9166, 69 FR 78746, Dec. 30, 2004, as amended by T.D. 9491, 75 FR 
37223, June 28, 2010]



Sec. 54.9801-4  Rules relating to creditable coverage.

    (a) General rules--(1) Creditable coverage. For purposes of this 
section, except as provided in paragraph (a)(2) of this section, the 
term creditable coverage means coverage of an individual under any of 
the following:
    (i) A group health plan as defined in Sec. 54.9831-1(a).
    (ii) Health insurance coverage as defined in Sec. 54.9801-2 
(whether or not the entity offering the coverage is subject to Chapter 
100 of Subtitle K, and without regard to whether the coverage is offered 
in the group market, the individual market, or otherwise).
    (iii) Part A or B of Title XVIII of the Social Security Act 
(Medicare).
    (iv) 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).
    (v) Title 10 U.S.C. Chapter 55 (medical and dental care for members 
and certain former members of the uniformed services, and for their 
dependents; for purposes of Title 10 U.S.C. Chapter 55, uniformed 
services means the armed forces and the Commissioned Corps of the 
National Oceanic and Atmospheric Administration and of the Public Health 
Service).
    (vi) A medical care program of the Indian Health Service or of a 
tribal organization.
    (vii) A State health benefits risk pool. For purposes of this 
section, a State health benefits risk pool means--
    (A) An organization qualifying under section 501(c)(26);
    (B) A qualified high risk pool described in section 2744(c)(2) of 
the PHS Act; or
    (C) Any other arrangement sponsored by a State, the membership 
composition of which is specified by the State and which is established 
and maintained primarily to provide health coverage for individuals who 
are residents of such State and who, by reason of the existence or 
history of a medical condition--
    (1) Are unable to acquire medical care coverage for such condition 
through insurance or from an HMO, or
    (2) Are able to acquire such coverage only at a rate which is 
substantially in excess of the rate for such coverage through the 
membership organization.

[[Page 419]]

    (viii) A health plan offered under Title 5 U.S.C. Chapter 89 (the 
Federal Employees Health Benefits Program).
    (ix) A public health plan. For purposes of this section, a public 
health plan means any plan established or maintained by a State, the 
U.S. government, a foreign country, or any political subdivision of a 
State, the U.S. government, or a foreign country that provides health 
coverage to individuals who are enrolled in the plan.
    (x) A health benefit plan under section 5(e) of the Peace Corps Act 
(22 U.S.C. 2504(e)).
    (xi) Title XXI of the Social Security Act (State Children's Health 
Insurance Program).
    (2) Excluded coverage. Creditable coverage does not include coverage 
of solely excepted benefits (described in Sec. 54.9831-1).
    (3) Methods of counting creditable coverage. For purposes of 
reducing any preexisting condition exclusion period, as provided under 
Sec. 54.9801-3(a)(2)(iii), the amount of an individual's creditable 
coverage generally is determined by using the standard method described 
in paragraph (b) of this section. A plan may use the alternative method 
under paragraph (c) of this section with respect to any or all of the 
categories of benefits described under paragraph (c)(3) of this section 
or may provide that a health insurance issuer offering health insurance 
coverage under the plan may use the alternative method of counting 
creditable coverage.
    (b) Standard method--(1) Specific benefits not considered. Under the 
standard method, the amount of creditable coverage is determined without 
regard to the specific benefits included in the coverage.
    (2) Counting creditable coverage--(i) Based on days. For purposes of 
reducing the preexisting condition exclusion period that applies to an 
individual, the amount of creditable coverage is determined by counting 
all the days on which the individual has one or more types of creditable 
coverage. Accordingly, if on a particular day an individual has 
creditable coverage from more than one source, all the creditable 
coverage on that day is counted as one day. Any days in a waiting period 
for coverage are not creditable coverage.
    (ii) Days not counted before significant break in coverage. Days of 
creditable coverage that occur before a significant break in coverage 
are not required to be counted.
    (iii) Significant break in coverage defined--A significant break in 
coverage means a period of 63 consecutive days during each of which an 
individual does not have any creditable coverage. (See section 
731(b)(2)(iii) of ERISA and section 2723(b)(2)(iii) of the PHS Act, 
which exclude from preemption State insurance laws that require a break 
of more than 63 days before an individual has a significant break in 
coverage for purposes of State law.)
    (iv) Periods that toll a significant break. Days in a waiting period 
and days in an affiliation period are not taken into account in 
determining whether a significant break in coverage has occurred. In 
addition, for an individual who elects COBRA continuation coverage 
during the second election period provided under the Trade Act of 2002, 
the days between the date the individual lost group health plan coverage 
and the first day of the second COBRA election period are not taken into 
account in determining whether a significant break in coverage has 
occurred.
    (v) Examples. The rules of this paragraph (b)(2) are illustrated by 
the following examples:

    Example 1. (i) Facts. Individual A has creditable coverage under 
Employer P's plan for 18 months before coverage ceases. A is provided a 
certificate of creditable coverage on A's last day of coverage. Sixty-
four days after the last date of coverage under P's plan, A is hired by 
Employer Q and enrolls in Q's group health plan. Q's plan has a 12-month 
preexisting condition exclusion.
    (ii) Conclusion. In this Example 1, A has a break in coverage of 63 
days. Because A's break in coverage is a significant break in coverage, 
Q's plan may disregard A's prior coverage and A may be subject to a 12-
month preexisting condition exclusion.
    Example 2. (i) Facts. Same facts as Example 1, except that A is 
hired by Q and enrolls in Q's plan on the 63rd day after the last date 
of coverage under P's plan.
    (ii) Conclusion. In this Example 2, A has a break in coverage of 62 
days. Because A's break in coverage is not a significant break in 
coverage, Q's plan must count A's prior

[[Page 420]]

creditable coverage for purposes of reducing the plan's preexisting 
condition exclusion period that applies to A.
    Example 3. (i) Facts. Same facts as Example 1, except that Q's plan 
provides benefits through an insurance policy that, as required by 
applicable State insurance laws, defines a significant break in coverage 
as 90 days.
    (ii) Conclusion. In this Example 3, under State law, the issuer that 
provides group health insurance coverage to Q's plan must count A's 
period of creditable coverage prior to the 63-day break. (However, if 
Q's plan was a self-insured plan, the coverage would not be subject to 
State law. Therefore, the health coverage would not be governed by the 
longer break rules and A's previous health coverage could be 
disregarded.)
    Example 4. [Reserved]
    Example 5. (i) Facts. Individual C has creditable coverage under 
Employer S's plan for 200 days before coverage ceases. C is provided a 
certificate of creditable coverage on C's last day of coverage. C then 
does not have any creditable coverage for 51 days before being hired by 
Employer T. T's plan has a 3-month waiting period. C works for T for 2 
months and then terminates employment. Eleven days after terminating 
employment with T, C begins working for Employer U. U's plan has no 
waiting period, but has a 6-month preexisting condition exclusion.
    (ii) Conclusion. In this Example 5, C does not have a significant 
break in coverage because, after disregarding the waiting period under 
T's plan, C had only a 62-day break in coverage (51 days plus 11 days). 
Accordingly, C has 200 days of creditable coverage, and U's plan may not 
apply its 6-month preexisting condition exclusion with respect to C.
    Example 6. [Reserved]
    Example 7. (i) Facts. Individual E has creditable coverage under 
Employer X's plan. E is provided a certificate of creditable coverage on 
E's last day of coverage. On the 63rd day without coverage, E submits a 
substantially complete application for a health insurance policy in the 
individual market. E's application is accepted and coverage is made 
effective 10 days later.
    (ii) Conclusion. In this Example 7, because E applied for the policy 
before the end of the 63rd day, the period between the date of 
application and the first day of coverage is a waiting period and no 
significant break in coverage occurred even though the actual period 
without coverage was 73 days.
    Example 8. (i) Facts. Same facts as Example 7, except that E's 
application for a policy in the individual market is denied.
    (ii) Conclusion. In this Example 8, even though E did not obtain 
coverage following application, the period between the date of 
application and the date the coverage was denied is a waiting period. 
However, to avoid a significant break in coverage, no later than the day 
after the application for the policy is denied E would need to do one of 
the following: submit a substantially complete application for a 
different individual market policy; obtain coverage in the group market; 
or be in a waiting period for coverage in the group market.

    (vi) Other permissible counting methods--(a) Rule. Notwithstanding 
any other provisions of this paragraph (b)(2), for purposes of reducing 
a preexisting condition exclusion period (but not for purposes of 
issuing a certificate under Sec. 54.9801-5), a group health plan may 
determine the amount of creditable coverage in any other manner that is 
at least as favorable to the individual as the method set forth in this 
paragraph (b)(2), subject to the requirements of other applicable law.
    (B) Example. The rule of this paragraph (b)(2)(vi) is illustrated by 
the following example:

    Example. (i) Facts. Individual F has coverage under Group Health 
Plan Y from January 3, 1997 through March 25, 1997. F then becomes 
covered by Group Health Plan Z. F's enrollment date in Plan Z is May 1, 
1997. Plan Z has a 12-month preexisting condition exclusion.
    (ii) Conclusion. In this Example, Plan Z may determine, in 
accordance with the rules prescribed in paragraphs (b)(2)(i), (ii), and 
(iii) of this section, that F has 82 days of creditable coverage (29 
days in January, 28 days in February, and 25 days in March). Thus, the 
preexisting condition exclusion will no longer apply to F on February 8, 
1998 (82 days before the 12-month anniversary of F's enrollment (May 
1)). For administrative convenience, however, Plan Z may consider that 
the preexisting condition exclusion will no longer apply to F on the 
first day of the month (February 1).

    (c) Alternative method--(1) Specific benefits considered. Under the 
alternative method, a group health plan determines the amount of 
creditable coverage based on coverage within any category of benefits 
described in paragraph (c)(3) of this section and not based on coverage 
for any other benefits. The plan may use the alternative method for any 
or all of the categories. The plan may apply a different preexisting 
condition exclusion period with respect to each category (and may apply 
a different preexisting condition exclusion period for benefits that are

[[Page 421]]

not within any category). The creditable coverage determined for a 
category of benefits applies only for purposes of reducing the 
preexisting condition exclusion period with respect to that category. An 
individual's creditable coverage for benefits that are not within any 
category for which the alternative method is being used is determined 
under the standard method of paragraph (b) of this section.
    (2) Uniform application. A plan using the alternative method is 
required to apply it uniformly to all participants and beneficiaries 
under the plan. A plan that provides benefits (in part or in whole) 
through one or more policies or contracts of insurance will not fail the 
uniform application requirement of this paragraph (c)(2) if the 
alternative method is used (or not used) separately with respect to 
participants and beneficiaries under any policy or contact, provided 
that the alternative method is applied uniformly with respect to all 
coverage under that policy or contract. The use of the alternative 
method is required to be set forth in the plan.
    (3) Categories of benefits. The alternative method for counting 
creditable coverage may be used for coverage for the following 
categories of benefits--
    (i) Mental health;
    (ii) Substance abuse treatment;
    (iii) Prescription drugs;
    (iv) Dental care; or
    (v) Vision care.
    (4) Plan notice. If the alternative method is used, the plan is 
required to--
    (i) State prominently that the plan is using the alternative method 
of counting creditable coverage in disclosure statements concerning the 
plan, and state this to each enrollee at the time of enrollment under 
the plan; and
    (ii) Include in these statements a description of the effect of 
using the alternative method, including an identification of the 
categories used.
    (5) Disclosure of information on previous benefits. See Sec. 
54.9801-5(b) for special rules concerning disclosure of coverage to a 
plan (or issuer) using the alternative method of counting creditable 
coverage under this paragraph (c).
    (6) Counting creditable coverage--(i) In general. Under the 
alternative method, the group health plan counts creditable coverage 
within a category if any level of benefits is provided within the 
category. Coverage under a reimbursement account or arrangement, such as 
a flexible spending arrangement (as defined in section 106(c)(2)), does 
not constitute coverage within any category.
    (ii) Special rules. In counting an individual's creditable coverage 
under the alternative method, the group health plan first determines the 
amount of the individual's creditable coverage that may be counted under 
paragraph (b) of this section, up to a total of 365 days of the most 
recent creditable coverage (546 days for a late enrollee). The period 
over which this creditable coverage is determined is referred to as the 
determination period. Then, for the category specified under the 
alternative method, the plan counts within the category all days of 
coverage that occurred during the determination period (whether or not a 
significant break in coverage for that category occurs), and reduces the 
individual's preexisting condition exclusion period for that category by 
that number of days. The plan may determine the amount of creditable 
coverage in any other reasonable manner, uniformly applied, that is at 
least as favorable to the individual.
    (iii) Example. The rules of this paragraph (c)(6) are illustrated by 
the following example:

    Example. (i) Facts. Individual D enrolls in Employer V's plan on 
January 1, 2001. Coverage under the plan includes prescription drug 
benefits. On April 1, 2001, the plan ceases providing prescription drug 
benefits. D's employment with Employer V ends on January 1, 2002, after 
D was covered under Employer V's group health plan for 365 days. D 
enrolls in Employer Y's plan on February 1, 2002 (D's enrollment date). 
Employer Y's plan uses the alternative method of counting creditable 
coverage and imposes a 12-month preexisting condition exclusion on 
prescription drug benefits.
    (ii) Conclusion. In this Example, Employer Y's plan may impose a 
275-day preexisting condition exclusion with respect to D for 
prescription drug benefits because D had 90 days of creditable coverage 
relating to prescription drug benefits within D's determination period.

[T.D. 9166, 69 FR 78746, Dec. 30, 2004]

[[Page 422]]



Sec. 54.9801-5  Evidence of creditable coverage.

    (a) Certificate of creditable coverage--(1) Entities required to 
provide certificate--(i) In general. A group health plan is required to 
furnish certificates of creditable coverage in accordance with this 
paragraph (a). (See section 701(e) of ERISA and section 2701(e) of the 
PHS Act, under which this obligation is also imposed on each health 
insurance issuer offering group health insurance coverage under the 
plan.)
    (ii) Duplicate certificates not required. An entity required to 
provide a certificate under this paragraph (a) with respect to an 
individual satisfies that requirement if another party provides the 
certificate, but only to the extent that the certificate contains the 
information required in paragraph (a)(3) of this section. For example, a 
group health plan is deemed to have satisfied the certification 
requirement with respect to a participant or beneficiary if any other 
entity actually provides a certificate that includes the information 
required under paragraph (a)(3) of this section with respect to the 
participant or beneficiary.
    (iii) Special rule for group health plans. To the extent coverage 
under a plan consists of group health insurance coverage, the plan 
satisfies the certification requirements under this paragraph (a) if any 
issuer offering the coverage is required to provide the certificates 
pursuant to an agreement between the plan and the issuer. For example, 
if there is an agreement between an issuer and an employer sponsoring a 
plan under which the issuer agrees to provide certificates for 
individuals covered under the plan, and the issuer fails to provide a 
certificate to an individual when the plan would have been required to 
provide one under this paragraph (a), then the plan does not violate the 
certification requirements of this paragraph (a) (though the issuer 
would have violated the certification requirements pursuant to section 
701(e) of ERISA and section 2701(e) of the PHS Act).
    (iv) Special rules relating to issuers providing coverage under a 
plan--(A)(1) Responsibility of issuer for coverage period. See 29 CFR 
2590.701-5 and 45 CFR 146.115, under which an issuer is not required to 
provide information regarding coverage provided to an individual by 
another party.
    (2) Example. The rule referenced by this paragraph (a)(1)(iv)(A) is 
illustrated by the following example:

    Example. (i) Facts. A plan offers coverage with an HMO option from 
one issuer and an indemnity option from a different issuer. The HMO has 
not entered into an agreement with the plan to provide certificates as 
permitted under paragraph (a)(1)(iii) of this section.
    (ii) Conclusion. In this Example, if an employee switches from the 
indemnity option to the HMO option and later ceases to be covered under 
the plan, any certificate provided by the HMO is not required to provide 
information regarding the employee's coverage under the indemnity 
option.

    (B)(1) Cessation of issuer coverage prior to cessation of coverage 
under a plan. If an individual's coverage under an issuer's policy or 
contract ceases before the individual's coverage under the plan ceases, 
the issuer is required (under section 701(e) of ERISA and section 
2701(e) of the PHS Act) to provide sufficient information to the plan 
(or to another party designated by the plan) to enable the plan (or 
other party), after cessation of the individual's coverage under the 
plan, to provide a certificate that reflects the period of coverage 
under the policy or contract. By providing that information to the plan, 
the issuer satisfies its obligation to provide an automatic certificate 
for that period of creditable coverage with respect to the individual 
under paragraph (a)(2)(ii) of this section. The issuer, however, must 
still provide a certificate upon request as required under paragraph 
(a)(2)(iii) of this section. In addition, the issuer is required to 
cooperate with the plan in responding to any request made under 
paragraph (b)(2) of this section (relating to the alternative method of 
counting creditable coverage). Moreover, if the individual's coverage 
under the plan ceases at the time the individual's coverage under the 
issuer's policy or contract ceases, the issuer must still provide an 
automatic certificate under paragraph (a)(2)(ii) of this section. If an 
individual's coverage under an issuer's policy or contract ceases on the 
effective date for changing enrollment options under the plan, the 
issuer may

[[Page 423]]

presume (absent information to the contrary) that the individual's 
coverage under the plan continues. Therefore, the issuer is required to 
provide information to the plan in accordance with this paragraph 
(a)(1)(iv)(B)(1) (and is not required to provide an automatic 
certificate under paragraph (a)(2)(ii) of this section).
    (2) Example. The rule of this paragraph (a)(1)(iv)(B) is illustrated 
by the following example:

    Example. (i) Facts. A group health plan provides coverage under an 
HMO option and an indemnity option through different issuers, and only 
allows employees to switch on each January 1. Neither the HMO nor the 
indemnity issuer has entered into an agreement with the plan to provide 
certificates as permitted under paragraph (a)(1)(iii) of this section.
    (ii) Conclusion. In this Example, if an employee switches from the 
indemnity option to the HMO option on January 1, the indemnity issuer 
must provide the plan (or a person designated by the plan) with 
appropriate information with respect to the individual's coverage with 
the indemnity issuer. However, if the individual's coverage with the 
indemnity issuer ceases at a date other than January 1, the issuer is 
instead required to provide the individual with an automatic 
certificate.

    (2) Individuals for whom certificate must be provided; timing of 
issuance--(i) Individuals. A certificate must be provided, without 
charge, for participants or dependents who are or were covered under a 
group health plan upon the occurrence of any of the events described in 
paragraph (a)(2)(ii) or (iii) of this section.
    (ii) Issuance of automatic certificates. The certificates described 
in this paragraph (a)(2)(ii) are referred to as automatic certificates.
    (A) Qualified beneficiaries upon a qualifying event. In the case of 
an individual who is a qualified beneficiary (as defined in section 
4980B(g)(3)) entitled to elect COBRA continuation coverage, an automatic 
certificate is required to be provided at the time the individual would 
lose coverage under the plan in the absence of COBRA continuation 
coverage or alternative coverage elected instead of COBRA continuation 
coverage. A plan satisfies this requirement if it provides the automatic 
certificate no later than the time a notice is required to be furnished 
for a qualifying event under section 4980B(f)(6) (relating to notices 
required under COBRA).
    (B) Other individuals when coverage ceases. In the case of an 
individual who is not a qualified beneficiary entitled to elect COBRA 
continuation coverage, an automatic certificate must be provided at the 
time the individual ceases to be covered under the plan. A plan 
satisfies the requirement to provide an automatic certificate at the 
time the individual ceases to be covered if it provides the automatic 
certificate within a reasonable time after coverage ceases (or after the 
expiration of any grace period for nonpayment of premiums).
    (1) The cessation of temporary continuation coverage (TCC) under 
Title 5 U.S.C. Chapter 89 (the Federal Employees Health Benefit Program) 
is a cessation of coverage upon which an automatic certificate must be 
provided.
    (2) In the case of an individual who is entitled to elect to 
continue coverage under a State program similar to COBRA and who 
receives the automatic certificate not later than the time a notice is 
required to be furnished under the State program, the certificate is 
deemed to be provided within a reasonable time after coverage ceases 
under the plan.
    (3) If an individual's coverage ceases due to the operation of a 
lifetime limit on all benefits, coverage is considered to cease for 
purposes of this paragraph (a)(2)(ii)(B) on the earliest date that a 
claim is denied due to the operation of the lifetime limit.
    (C) Qualified beneficiaries when COBRA ceases. In the case of an 
individual who is a qualified beneficiary and has elected COBRA 
continuation coverage (or whose coverage has continued after the 
individual became entitled to elect COBRA continuation coverage), an 
automatic certificate is to be provided at the time the individual' s 
coverage under the plan ceases. A plan satisfies this requirement if it 
provides the automatic certificate within a reasonable time after 
coverage ceases (or after the expiration of any grace period for 
nonpayment of premiums). An automatic certificate is

[[Page 424]]

required to be provided to such an individual regardless of whether the 
individual has previously received an automatic certificate under 
paragraph (a)(2)(ii)(A) of this section.
    (iii) Any individual upon request. A certificate must be provided in 
response to a request made by, or on behalf of, an individual at any 
time while the individual is covered under a plan and up to 24 months 
after coverage ceases. Thus, for example, a plan in which an individual 
enrolls may, if authorized by the individual, request a certificate of 
the individual's creditable coverage on behalf of the individual from a 
plan in which the individual was formerly enrolled. After the request is 
received, a plan or issuer is required to provide the certificate by the 
earliest date that the plan, acting in a reasonable and prompt fashion, 
can provide the certificate. A certificate is required to be provided 
under this paragraph (a)(2)(iii) even if the individual has previously 
received a certificate under this paragraph (a)(2)(iii) or an automatic 
certificate under paragraph (a)(2)(ii) of this section.
    (iv) Examples. The rules of this paragraph (a)(2) are illustrated by 
the following examples:

    Example 1. (i) Facts. Individual A terminates employment with 
Employer Q. A is a qualified beneficiary entitled to elect COBRA 
continuation coverage under Employer Q's group health plan. A notice of 
the rights provided under COBRA is typically furnished to qualified 
beneficiaries under the plan within 10 days after a covered employee 
terminates employment.
    (ii) Conclusion. In this Example 1, the automatic certificate may be 
provided at the same time that A is provided the COBRA notice.
    Example 2. (i) Facts. Same facts as Example 1, except that the 
automatic certificate for A is not completed by the time the COBRA 
notice is furnished to A.
    (ii) Conclusion. In this Example 2, the automatic certificate may be 
provided after the COBRA notice but must be provided within the period 
permitted by law for the delivery of notices under COBRA.
    Example 3. (i) Facts. Employer R maintains an insured group health 
plan. R has never had 20 employees and thus R's plan is not subject to 
the COBRA continuation provisions. However, R is in a State that has a 
State program similar to COBRA. B terminates employment with R and loses 
coverage under R's plan.
    (ii) Conclusion. In this Example 3, the automatic certificate must 
be provided not later than the time a notice is required to be furnished 
under the State program.
    Example 4. (i) Facts. Individual C terminates employment with 
Employer S and receives both a notice of C's rights under COBRA and an 
automatic certificate. C elects COBRA continuation coverage under 
Employer S's group health plan. After four months of COBRA continuation 
coverage and the expiration of a 30-day grace period, S's group health 
plan determines that C's COBRA continuation coverage has ceased due to a 
failure to make a timely payment for continuation coverage.
    (ii) Conclusion. In this Example 4, the plan must provide an updated 
automatic certificate to C within a reasonable time after the end of the 
grace period.
    Example 5. (i) Facts. Individual D is currently covered under the 
group health plan of Employer T. D requests a certificate, as permitted 
under paragraph (a)(2)(iii) of this section. Under the procedure for T's 
plan, certificates are mailed (by first class mail) 7 business days 
following receipt of the request. This date reflects the earliest date 
that the plan, acting in a reasonable and prompt fashion, can provide 
certificates.
    (ii) Conclusion. In this Example 5, the plan's procedure satisfies 
paragraph (a)(2)(iii) of this section.

    (3) Form and content of certificate--(i) Written certificate--(A) In 
general. Except as provided in paragraph (a)(3)(i)(B) of this section, 
the certificate must be provided in writing (including any form approved 
by the Secretary as a writing).
    (B) Other permissible forms. No written certificate is required to 
be provided under this paragraph (a) with respect to a particular event 
described in paragraph (a)(2)(ii) or (iii) of this section, if--
    (1) An individual who is entitled to receive the certificate 
requests that the certificate be sent to another plan or issuer instead 
of to the individual;
    (2) The plan or issuer that would otherwise receive the certificate 
agrees to accept the information in this paragraph (a)(3) through means 
other than a written certificate (such as by telephone); and
    (3) The receiving plan or issuer receives the information from the 
sending plan or issuer through such means within the time required under 
paragraph (a)(2) of this section.
    (ii) Required information. The certificate must include the 
following--

[[Page 425]]

    (A) The date the certificate is issued;
    (B) The name of the group health plan that provided the coverage 
described in the certificate;
    (C) The name of the participant or dependent with respect to whom 
the certificate applies, and any other information necessary for the 
plan providing the coverage specified in the certificate to identify the 
individual, such as the individual's identification number under the 
plan and the name of the participant if the certificate is for (or 
includes) a dependent;
    (D) The name, address, and telephone number of the plan 
administrator or issuer required to provide the certificate;
    (E) The telephone number to call for further information regarding 
the certificate (if different from paragraph (a)(3)(ii)(D) of this 
section);
    (F) Either--
    (1) A statement that an individual has at least 18 months (for this 
purpose, 546 days is deemed to be 18 months) of creditable coverage, 
disregarding days of creditable coverage before a significant break in 
coverage, or
    (2) The date any waiting period (and affiliation period, if 
applicable) began and the date creditable coverage began;
    (G) The date creditable coverage ended, unless the certificate 
indicates that creditable coverage is continuing as of the date of the 
certificate; and
    (H) An educational statement regarding HIPAA, which explains:
    (1) The restrictions on the ability of a plan or issuer to impose a 
preexisting condition exclusion (including an individual's ability to 
reduce a preexisting condition exclusion by creditable coverage);
    (2) Special enrollment rights;
    (3) The prohibitions against discrimination based on any health 
factor;
    (4) The right to individual health coverage;
    (5) The fact that State law may require issuers to provide 
additional protections to individuals in that State; and
    (6) Where to get more information.
    (iii) Periods of coverage under the certificate. If an automatic 
certificate is provided pursuant to paragraph (a)(2)(ii) of this 
section, the period that must be included on the certificate is the last 
period of continuous coverage ending on the date coverage ceased. If an 
individual requests a certificate pursuant to paragraph (a)(2)(iii) of 
this section, the certificate provided must include each period of 
continuous coverage ending within the 24-month period ending on the date 
of the request (or continuing on the date of the request). A separate 
certificate may be provided for each such period of continuous coverage.
    (iv) Combining information for families. A certificate may provide 
information with respect to both a participant and the participant's 
dependents if the information is identical for each individual. If the 
information is not identical, certificates may be provided on one form 
if the form provides all the required information for each individual 
and separately states the information that is not identical.
    (v) Model certificate. The requirements of paragraph (a)(3)(ii) of 
this section are satisfied if the plan provides a certificate in 
accordance with a model certificate authorized by the Secretary.
    (vi) Excepted benefits; categories of benefits. No certificate is 
required to be furnished with respect to excepted benefits described in 
Sec. 54.9831-1(c). In addition, the information in the certificate 
regarding coverage is not required to specify categories of benefits 
described in Sec. 54.9801-4(c) (relating to the alternative method of 
counting creditable coverage). However, if excepted benefits are 
provided concurrently with other creditable coverage (so that the 
coverage does not consist solely of excepted benefits), information 
concerning the benefits may be required to be disclosed under paragraph 
(b) of this section.
    (4) Procedures--(i) Method of delivery. The certificate is required 
to be provided to each individual described in paragraph (a)(2) of this 
section or an entity requesting the certificate on behalf of the 
individual. The certificate may be provided by first-class mail. If the 
certificate or certificates are provided to the participant and the 
participant's spouse at the participant's

[[Page 426]]

last known address, then the requirements of this paragraph (a)(4) are 
satisfied with respect to all individuals residing at that address. If a 
dependent's last known address is different than the participant's last 
known address, a separate certificate is required to be provided to the 
dependent at the dependent's last known address. If separate 
certificates are being provided by mail to individuals who reside at the 
same address, separate mailings of each certificate are not required.
    (ii) Procedure for requesting certificates. A plan or issuer must 
establish a written procedure for individuals to request and receive 
certificates pursuant to paragraph (a)(2)(iii) of this section. The 
written procedure must include all contact information necessary to 
request a certificate (such as name and phone number or address).
    (iii) Designated recipients. If an automatic certificate is required 
to be provided under paragraph (a)(2)(ii) of this section, and the 
individual entitled to receive the certificate designates another 
individual or entity to receive the certificate, the plan or issuer 
responsible for providing the certificate is permitted to provide the 
certificate to the designated individual or entity. If a certificate is 
required to be provided upon request under paragraph (a)(2)(iii) of this 
section and the individual entitled to receive the certificate 
designates another individual or entity to receive the certificate, the 
plan or issuer responsible for providing the certificate is required to 
provide the certificate to the designated individual or entity.
    (5) Special rules concerning dependent coverage--(i)(A) Reasonable 
efforts. A plan is required to use reasonable efforts to determine any 
information needed for a certificate relating to dependent coverage. In 
any case in which an automatic certificate is required to be furnished 
with respect to a dependent under paragraph (a)(2)(ii) of this section, 
no individual certificate is required to be furnished until the plan 
knows (or making reasonable efforts should know) of the dependent's 
cessation of coverage under the plan.
    (B) Example. The rules of this paragraph (a)(5)(i) are illustrated 
by the following example:

    Example. (i) Facts. A group health plan covers employees and their 
dependents. The plan annually requests all employees to provide updated 
information regarding dependents, including the specific date on which 
an employee has a new dependent or on which a person ceases to be a 
dependent of the employee.
    (ii) Conclusion. In this Example, the plan has satisfied the 
standard in this paragraph (a)(5)(i) of this section that it make 
reasonable efforts to determine the cessation of dependents' coverage 
and the related dependent coverage information.

    (ii) Special rules for demonstrating coverage. If a certificate 
furnished by a plan or issuer does not provide the name of any dependent 
covered by the certificate, the procedures described in paragraph (c)(5) 
of this section may be used to demonstrate dependent status. In 
addition, these procedures may be used to demonstrate that a child was 
covered under any creditable coverage within 30 days after birth, 
adoption, or placement for adoption. See also Sec. 54.9801-3(b), under 
which such a child cannot be subject to a preexisting condition 
exclusion.
    (6) Special certification rules for entities not subject to Chapter 
100 of Subtitle K--(i) Issuers. For rules requiring that issuers in the 
group and individual markets provide certificates consistent with the 
rules in this section, see section 701(e) of ERISA and sections 2701(e), 
2721(b)(1)(B), and 2743 of the PHS Act.
    (ii) Other entities. For special rules requiring that certain other 
entities not subject to Chapter 100 of Subtitle K provide certificates 
consistent with the rules in this section, see section 2791(a)(3) of the 
PHS Act applicable to entities described in sections 2701(c)(1)(C), (D), 
(E), and (F) of the PHS Act (relating to Medicare, Medicaid, TRICARE, 
and Indian Health Service), section 2721(b)(1)(A) of the PHS Act 
applicable to nonfederal governmental plans generally, and section 
2721(b)(2)(C)(ii) of the PHS Act applicable to nonfederal governmental 
plans that elect to be excluded from the requirements of Subparts 1 
through 3 of Part A of Title XXVII of the PHS Act.
    (b) Disclosure of coverage to a plan or issuer using the alternative 
method of

[[Page 427]]

counting creditable coverage--(1) In general. After an individual 
provides a certificate of creditable coverage to a plan (or issuer) 
using the alternative method under Sec. 54.9801-4(c), that plan (or 
issuer) (requesting entity) must request that the entity that issued the 
certificate (prior entity) disclose the information set forth in 
paragraph (b)(2) of this section. The prior entity is required to 
disclose this information promptly.
    (2) Information to be disclosed. The prior entity is required to 
identify to the requesting entity the categories of benefits with 
respect to which the requesting entity is using the alternative method 
of counting creditable coverage, and the requesting entity may identify 
specific information that the requesting entity reasonably needs in 
order to determine the individual's creditable coverage with respect to 
any such category.
    (3) Charge for providing information. The prior entity may charge 
the requesting entity for the reasonable cost of disclosing such 
information.
    (c) Ability of an individual to demonstrate creditable coverage and 
waiting period information--(1) Purpose. The rules in this paragraph (c) 
implement section 9801(c)(4), which permits individuals to demonstrate 
the duration of creditable coverage through means other than 
certificates, and section 9801(e)(3), which requires the Secretary to 
establish rules designed to prevent an individual's subsequent coverage 
under a group health plan or health insurance coverage from being 
adversely affected by an entity's failure to provide a certificate with 
respect to that individual.
    (2) In general. If the accuracy of a certificate is contested or a 
certificate is unavailable when needed by an individual, the individual 
has the right to demonstrate creditable coverage (and waiting or 
affiliation periods) through the presentation of documents or other 
means. For example, the individual may make such a demonstration when--
    (i) An entity has failed to provide a certificate within the 
required time;
    (ii) The individual has creditable coverage provided by an entity 
that is not required to provide a certificate of the coverage pursuant 
to paragraph (a) of this section;
    (iii) The individual has an urgent medical condition that 
necessitates a determination before the individual can deliver a 
certificate to the plan; or
    (iv) The individual lost a certificate that the individual had 
previously received and is unable to obtain another certificate.
    (3) Evidence of creditable coverage--(i) Consideration of evidence--
(A) A plan is required to take into account all information that it 
obtains or that is presented on behalf of an individual to make a 
determination, based on the relevant facts and circumstances, whether an 
individual has creditable coverage. A plan shall treat the individual as 
having furnished a certificate under paragraph (a) of this section if--
    (1) The individual attests to the period of creditable coverage;
    (2) The individual also presents relevant corroborating evidence of 
some creditable coverage during the period; and
    (3) The individual cooperates with the plan's efforts to verify the 
individual's coverage.
    (B) For purposes of this paragraph (c)(3)(i), cooperation includes 
providing (upon the plan's or issuer's request) a written authorization 
for the plan to request a certificate on behalf of the individual, and 
cooperating in efforts to determine the validity of the corroborating 
evidence and the dates of creditable coverage. While a plan may refuse 
to credit coverage where the individual fails to cooperate with the 
plan's or issuer's efforts to verify coverage, the plan may not consider 
an individual's inability to obtain a certificate to be evidence of the 
absence of creditable coverage.
    (ii) Documents. Documents that corroborate creditable coverage (and 
waiting or affiliation periods) include explanations of benefits (EOBs) 
or other correspondence from a plan or issuer indicating coverage, pay 
stubs showing a payroll deduction for health coverage, a health 
insurance identification card, a certificate of coverage under a group 
health policy, records from medical care providers indicating health 
coverage, third party statements verifying periods of coverage, and any

[[Page 428]]

other relevant documents that evidence periods of health coverage.
    (iii) Other evidence. Creditable coverage (and waiting or 
affiliation periods) may also be corroborated through means other than 
documentation, such as by a telephone call from the plan or provider to 
a third party verifying creditable coverage.
    (iv) Example. The rules of this paragraph (c)(3) are illustrated by 
the following example:

    Example. (i) Facts. Individual F terminates employment with Employer 
W and, a month later, is hired by Employer X. X's group health plan 
imposes a preexisting condition exclusion of 12 months on new enrollees 
under the plan and uses the standard method of determining creditable 
coverage. F fails to receive a certificate of prior coverage from the 
self-insured group health plan maintained by F's prior employer, W, and 
requests a certificate. However, F (and X's plan, on F's behalf and with 
F's cooperation) is unable to obtain a certificate from W's plan. F 
attests that, to the best of F's knowledge, F had at least 12 months of 
continuous coverage under W's plan, and that the coverage ended no 
earlier than F's termination of employment from W. In addition, F 
presents evidence of coverage, such as an explanation of benefits for a 
claim that was made during the relevant period.
    (ii) Conclusion. In this Example, based solely on these facts, F has 
demonstrated creditable coverage for the 12 months of coverage under W's 
plan in the same manner as if F had presented a written certificate of 
creditable coverage.

    (4) Demonstrating categories of creditable coverage. Procedures 
similar to those described in this paragraph (c) apply in order to 
determine the duration of an individual's creditable coverage with 
respect to any category under paragraph (b) of this section (relating to 
determining creditable coverage under the alternative method).
    (5) Demonstrating dependent status. If, in the course of providing 
evidence (including a certificate) of creditable coverage, an individual 
is required to demonstrate dependent status, the group health plan or 
issuer is required to treat the individual as having furnished a 
certificate showing the dependent status if the individual attests to 
such dependency and the period of such status and the individual 
cooperates with the plan's or issuer's efforts to verify the dependent 
status.

[T.D. 9166, 69 FR 78746, Dec. 30, 2004]



Sec. 54.9801-6  Special enrollment periods.

    (a) Special enrollment for certain individuals who lose coverage--
(1) In general. A group health plan is required to permit current 
employees and dependents (as defined in Sec. 54.9801-2) who are 
described in paragraph (a)(2) of this section to enroll for coverage 
under the terms of the plan if the conditions in paragraph (a)(3) of 
this section are satisfied. The special enrollment rights under this 
paragraph (a) apply without regard to the dates on which an individual 
would otherwise be able to enroll under the plan. (See section 701(f)(1) 
of ERISA and section 2701(f)(1) of the PHS Act, under which this 
obligation is also imposed on a health insurance issuer offering group 
health insurance coverage.)
    (2) Individuals eligible for special enrollment--(i) When employee 
loses coverage. A current employee and any dependents (including the 
employee's spouse) each are eligible for special enrollment in any 
benefit package under the plan (subject to plan eligibility rules 
conditioning dependent enrollment on enrollment of the employee) if--
    (A) The employee and the dependents are otherwise eligible to enroll 
in the benefit package;
    (B) When coverage under the plan was previously offered, the 
employee had coverage under any group health plan or health insurance 
coverage; and
    (C) The employee satisfies the conditions of paragraph (a)(3)(i), 
(ii), or (iii) of this section and, if applicable, paragraph (a)(3)(iv) 
of this section.
    (ii) When dependent loses coverage--(A) A dependent of a current 
employee (including the employee's spouse) and the employee each are 
eligible for special enrollment in any benefit package under the plan 
(subject to plan eligibility rules conditioning dependent enrollment on 
enrollment of the employee) if--
    (1) The dependent and the employee are otherwise eligible to enroll 
in the benefit package;
    (2) When coverage under the plan was previously offered, the 
dependent had

[[Page 429]]

coverage under any group health plan or health insurance coverage; and
    (3) The dependent satisfies the conditions of paragraph (a)(3)(i), 
(ii), or (iii) of this section and, if applicable, paragraph (a)(3)(iv) 
of this section.
    (B) However, the plan is not required to enroll any other dependent 
unless that dependent satisfies the criteria of this paragraph 
(a)(2)(ii), or the employee satisfies the criteria of paragraph 
(a)(2)(i) of this section.
    (iii) Examples. The rules of this paragraph (a)(2) are illustrated 
by the following examples:

    Example 1. (i) Facts. Individual A works for Employer X. A, A's 
spouse, and A's dependent children are eligible but not enrolled for 
coverage under X's group health plan. A's spouse works for Employer Y 
and at the time coverage was offered under X's plan, A was enrolled in 
coverage under Y's plan. Then, A loses eligibility for coverage under 
Y's plan.
    (ii) Conclusion. In this Example 1, because A satisfies the 
conditions for special enrollment under paragraph (a)(2)(i) of this 
section, A, A's spouse, and A's dependent children are eligible for 
special enrollment under X's plan.
    Example 2. (i) Facts. Individual A and A's spouse are eligible but 
not enrolled for coverage under Group Health Plan P maintained by A's 
employer. When A was first presented with an opportunity to enroll A and 
A's spouse, they did not have other coverage. Later, A and A's spouse 
enroll in Group Health Plan Q maintained by the employer of A's spouse. 
During a subsequent open enrollment period in P, A and A's spouse did 
not enroll because of their coverage under Q. They then lose eligibility 
for coverage under Q.
    (ii) Conclusion. In this Example 2, because A and A's spouse were 
covered under Q when they did not enroll in P during open enrollment, 
they satisfy the conditions for special enrollment under paragraphs 
(a)(2)(i) and (ii) of this section. Consequently, A and A's spouse are 
eligible for special enrollment under P.
    Example 3. (i) Facts. Individual B works for Employer X. B and B's 
spouse are eligible but not enrolled for coverage under X's group health 
plan. B's spouse works for Employer Y and at the time coverage was 
offered under X's plan, B's spouse was enrolled in self-only coverage 
under Y's group health plan. Then, B's spouse loses eligibility for 
coverage under Y's plan.
    (ii) Conclusion. In this Example 3, because B's spouse satisfies the 
conditions for special enrollment under paragraph (a)(2)(ii) of this 
section, both B and B's spouse are eligible for special enrollment under 
X's plan.
    Example 4. (i) Facts. Individual A works for Employer X. X maintains 
a group health plan with two benefit packages--an HMO option and an 
indemnity option. Self-only and family coverage are available under both 
options. A enrolls for self-only coverage in the HMO option. A's spouse 
works for Employer Y and was enrolled for self-only coverage under Y's 
plan at the time coverage was offered under X's plan. Then, A's spouse 
loses coverage under Y's plan. A requests special enrollment for A and 
A's spouse under the plan's indemnity option.
    (ii) Conclusion. In this Example 4, because A's spouse satisfies the 
conditions for special enrollment under paragraph (a)(2)(ii) of this 
section, both A and A's spouse can enroll in either benefit package 
under X's plan. Therefore, if A requests enrollment in accordance with 
the requirements of this section, the plan must allow A and A's spouse 
to enroll in the indemnity option.

    (3) Conditions for special enrollment--(i) Loss of eligibility for 
coverage. In the case of an employee or dependent who has coverage that 
is not COBRA continuation coverage, the conditions of this paragraph 
(a)(3)(i) are satisfied at the time the coverage is terminated as a 
result of loss of eligibility (regardless of whether the individual is 
eligible for or elects COBRA continuation coverage). Loss of eligibility 
under this paragraph (a)(3)(i) does not include a loss due to the 
failure of the employee or dependent to pay premiums on a timely basis 
or termination of coverage for cause (such as making a fraudulent claim 
or an intentional misrepresentation of a material fact in connection 
with the plan). Loss of eligibility for coverage under this paragraph 
(a)(3)(i) includes (but is not limited to)--
    (A) Loss of eligibility for coverage as a result of legal 
separation, divorce, cessation of dependent status (such as attaining 
the maximum age to be eligible as a dependent child under the plan), 
death of an employee, termination of employment, reduction in the number 
of hours of employment, and any loss of eligibility for coverage after a 
period that is measured by reference to any of the foregoing;
    (B) In the case of coverage offered through an HMO, or other 
arrangement, in the individual market that does not provide benefits to 
individuals who no longer reside, live, or work in a service area, loss 
of coverage because

[[Page 430]]

an individual no longer resides, lives, or works in the service area 
(whether or not within the choice of the individual);
    (C) In the case of coverage offered through an HMO, or other 
arrangement, in the group market that does not provide benefits to 
individuals who no longer reside, live, or work in a service area, loss 
of coverage because an individual no longer resides, lives, or works in 
the service area (whether or not within the choice of the individual), 
and no other benefit package is available to the individual;
    (D) A situation in which an individual incurs a claim that would 
meet or exceed a lifetime limit on all benefits; and
    (E) A situation in which a plan no longer offers any benefits to the 
class of similarly situated individuals (as described in Sec. 54.9802-
1(d)) that includes the individual.
    (ii) Termination of employer contributions. In the case of an 
employee or dependent who has coverage that is not COBRA continuation 
coverage, the conditions of this paragraph (a)(3)(ii) are satisfied at 
the time employer contributions towards the employee's or dependent's 
coverage terminate. Employer contributions include contributions by any 
current or former employer that was contributing to coverage for the 
employee or dependent.
    (iii) Exhaustion of COBRA continuation coverage. In the case of an 
employee or dependent who has coverage that is COBRA continuation 
coverage, the conditions of this paragraph (a)(3)(iii) are satisfied at 
the time the COBRA continuation coverage is exhausted. For purposes of 
this paragraph (a)(3)(iii), an individual who satisfies the conditions 
for special enrollment of paragraph (a)(3)(i) of this section, does not 
enroll, and instead elects and exhausts COBRA continuation coverage 
satisfies the conditions of this paragraph (a)(3)(iii). (Exhaustion of 
COBRA continuation coverage is defined in Sec. 54.9801-2.)
    (iv) Written statement. A plan may require an employee declining 
coverage (for the employee or any dependent of the employee) to state in 
writing whether the coverage is being declined due to other health 
coverage only if, at or before the time the employee declines coverage, 
the employee is provided with notice of the requirement to provide the 
statement (and the consequences of the employee's failure to provide the 
statement). If a plan requires such a statement, and an employee does 
not provide it, the plan is not required to provide special enrollment 
to the employee or any dependent of the employee under this paragraph 
(a)(3). A plan must treat an employee as having satisfied the plan 
requirement permitted under this paragraph (a)(3)(iv) if the employee 
provides a written statement that coverage was being declined because 
the employee or dependent had other coverage; a plan cannot require 
anything more for the employee to satisfy the plan's requirement to 
provide a written statement. (For example, the plan cannot require that 
the statement be notarized.)
    (v) The rules of this paragraph (a)(3) are illustrated by the 
following examples:

    Example 1. (i) Facts. Individual D enrolls in a group health plan 
maintained by Employer Y. At the time D enrolls, Y pays 70 percent of 
the cost of employee coverage and D pays the rest. Y announces that 
beginning January 1, Y will no longer make employer contributions 
towards the coverage. Employees may maintain coverage, however, if they 
pay the total cost of the coverage.
    (ii) Conclusion. In this Example 1, employer contributions towards 
D's coverage ceased on January 1 and the conditions of paragraph 
(a)(3)(ii) of this section are satisfied on this date (regardless of 
whether D elects to pay the total cost and continue coverage under Y's 
plan).
    Example 2. (i) Facts. A group health plan provides coverage through 
two options--Option 1 and Option 2. Employees can enroll in either 
option only within 30 days of hire or on January 1 of each year. 
Employee A is eligible for both options and enrolls in Option 1. 
Effective July 1 the plan terminates coverage under Option 1 and the 
plan does not create an immediate open enrollment opportunity into 
Option 2.
    (ii) Conclusion. In this Example 2, A has experienced a loss of 
eligibility for coverage that satisfies paragraph (a)(3)(i) of this 
section, and has satisfied the other conditions for special enrollment 
under paragraph (a)(2)(i) of this section. Therefore, if A satisfies the 
other conditions of this paragraph (a), the plan must permit A to enroll 
in Option 2 as a special enrollee. (A may also be eligible to enroll in 
another group health

[[Page 431]]

plan, such as a plan maintained by the employer of A's spouse, as a 
special enrollee.) The outcome would be the same if Option 1 was 
terminated by an issuer and the plan made no other coverage available to 
A.
    Example 3. (i) Facts. Individual C is covered under a group health 
plan maintained by Employer X. While covered under X's plan, C was 
eligible for but did not enroll in a plan maintained by Employer Z, the 
employer of C's spouse. C terminates employment with X and loses 
eligibility for coverage under X's plan. C has a special enrollment 
right to enroll in Z's plan, but C instead elects COBRA continuation 
coverage under X's plan. C exhausts COBRA continuation coverage under 
X's plan and requests special enrollment in Z's plan.
    (ii) Conclusion. In this Example 3, C has satisfied the conditions 
for special enrollment under paragraph (a)(3)(iii) of this section, and 
has satisfied the other conditions for special enrollment under 
paragraph (a)(2)(i) of this section. The special enrollment right that C 
had into Z's plan immediately after the loss of eligibility for coverage 
under X's plan was an offer of coverage under Z's plan. When C later 
exhausts COBRA coverage under X's plan, C has a second special 
enrollment right in Z's plan.

    (4) Applying for special enrollment and effective date of coverage--
(i) A plan or issuer must allow an employee a period of at least 30 days 
after an event described in paragraph (a)(3) of this section (other than 
an event described in paragraph (a)(3)(i)(D)) to request enrollment (for 
the employee or the employee's dependent). In the case of an event 
described in paragraph (a)(3)(i)(D) of this section (relating to loss of 
eligibility for coverage due to the operation of a lifetime limit on all 
benefits), a plan or issuer must allow an employee a period of at least 
30 days after a claim is denied due to the operation of a lifetime limit 
on all benefits.
    (ii) Coverage must begin no later than the first day of the first 
calendar month beginning after the date the plan or issuer receives the 
request for special enrollment.
    (b) Special enrollment with respect to certain dependent 
beneficiaries--(1) In general. A group health plan that makes coverage 
available with respect to dependents is required to permit individuals 
described in paragraph (b)(2) of this section to be enrolled for 
coverage in a benefit package under the terms of the plan. Paragraph 
(b)(3) of this section describes the required special enrollment period 
and the date by which coverage must begin. The special enrollment rights 
under this paragraph (b) apply without regard to the dates on which an 
individual would otherwise be able to enroll under the plan. (See 29 CFR 
2590.701-6(b) and 45 CFR 146.117(b), under which this obligation is also 
imposed on a health insurance issuer offering group health insurance 
coverage.)
    (2) Individuals eligible for special enrollment. An individual is 
described in this paragraph (b)(2) if the individual is otherwise 
eligible for coverage in a benefit package under the plan and if the 
individual is described in paragraph (b)(2)(i), (ii), (iii), (iv), (v), 
or (vi) of this section.
    (i) Current employee only. A current employee is described in this 
paragraph (b)(2)(i) if a person becomes a dependent of the individual 
through marriage, birth, adoption, or placement for adoption.
    (ii) Spouse of a participant only. An individual is described in 
this paragraph (b)(2)(ii) if either--
    (A) The individual becomes the spouse of a participant; or
    (B) The individual is a spouse of a participant and a child becomes 
a dependent of the participant through birth, adoption, or placement for 
adoption.
    (iii) Current employee and spouse. A current employee and an 
individual who is or becomes a spouse of such an employee, are described 
in this paragraph (b)(2)(iii) if either--
    (A) The employee and the spouse become married; or
    (B) The employee and spouse are married and a child becomes a 
dependent of the employee through birth, adoption, or placement for 
adoption.
    (iv) Dependent of a participant only. An individual is described in 
this paragraph (b)(2)(iv) if the individual is a dependent (as defined 
in Sec. 54.9801-2) of a participant and the individual has become a 
dependent of the participant through marriage, birth, adoption, or 
placement for adoption.
    (v) Current employee and a new dependent. A current employee and an 
individual who is a dependent of the employee, are described in this 
paragraph

[[Page 432]]

(b)(2)(v) if the individual becomes a dependent of the employee through 
marriage, birth, adoption, or placement for adoption.
    (vi) Current employee, spouse, and a new dependent. A current 
employee, the employee's spouse, and the employee's dependent are 
described in this paragraph (b)(2)(vi) if the dependent becomes a 
dependent of the employee through marriage, birth, adoption, or 
placement for adoption.
    (3) Applying for special enrollment and effective date of coverage--
(i) Request. A plan must allow an individual a period of at least 30 
days after the date of the marriage, birth, adoption, or placement for 
adoption (or, if dependent coverage is not generally made available at 
the time of the marriage, birth, adoption, or placement for adoption, a 
period of at least 30 days after the date the plan makes dependent 
coverage generally available) to request enrollment (for the individual 
or the individual's dependent).
    (ii) Reasonable procedures for special enrollment. [Reserved]
    (iii) Date coverage must begin--(A) Marriage. In the case of 
marriage, coverage must begin no later than the first day of the first 
calendar month beginning after the date the plan (or any issuer offering 
health insurance coverage under the plan) receives the request for 
special enrollment.
    (B) Birth, adoption, or placement for adoption. Coverage must begin 
in the case of a dependent's birth on the date of birth and in the case 
of a dependent's adoption or placement for adoption no later than the 
date of such adoption or placement for adoption (or, if dependent 
coverage is not made generally available at the time of the birth, 
adoption, or placement for adoption, the date the plan makes dependent 
coverage available).
    (4) Examples. The rules of this paragraph (b) are illustrated by the 
following examples:

    Example 1. (i) Facts. An employer maintains a group health plan that 
offers all employees employee-only coverage, employee-plus-spouse 
coverage, or family coverage. Under the terms of the plan, any employee 
may elect to enroll when first hired (with coverage beginning on the 
date of hire) or during an annual open enrollment period held each 
December (with coverage beginning the following January 1). Employee A 
is hired on September 3. A is married to B, and they have no children. 
On March 15 in the following year a child C is born to A and B. Before 
that date, A and B have not been enrolled in the plan.
    (ii) Conclusion. In this Example 1, the conditions for special 
enrollment of an employee with a spouse and new dependent under 
paragraph (b)(2)(vi) of this section are satisfied. If A satisfies the 
conditions of paragraph (b)(3) of this section for requesting enrollment 
timely, the plan will satisfy this paragraph (b) if it allows A to 
enroll either with employee-only coverage, with employee-plus-spouse 
coverage (for A and B), or with family coverage (for A, B, and C). The 
plan must allow whatever coverage is chosen to begin on March 15, the 
date of C's birth.
    Example 2. (i) Facts. Individual D works for Employer X. X maintains 
a group health plan with two benefit packages--an HMO option and an 
indemnity option. Self-only and family coverage are available under both 
options. D enrolls for self-only coverage in the HMO option. Then, a 
child, E, is placed for adoption with D. Within 30 days of the placement 
of E for adoption, D requests enrollment for D and E under the plan's 
indemnity option.
    (ii) Conclusion. In this Example 2, D and E satisfy the conditions 
for special enrollment under paragraphs (b)(2)(v) and (b)(3) of this 
section. Therefore, the plan must allow D and E to enroll in the 
indemnity coverage, effective as of the date of the placement for 
adoption.

    (c) Notice of special enrollment. At or before the time an employee 
is initially offered the opportunity to enroll in a group health plan, 
the plan must furnish the employee with a notice of special enrollment 
that complies with the requirements of this paragraph (c).
    (1) Description of special enrollment rights. The notice of special 
enrollment must include a description of special enrollment rights. The 
following model language may be used to satisfy this requirement:

    If you are declining enrollment for yourself or your dependents 
(including your spouse) because of other health insurance or group 
health plan coverage, you may be able to enroll yourself and your 
dependents in this plan if you or your dependents lose eligibility for 
that other coverage (or if the employer stops contributing towards your 
or your dependents' other coverage). However, you must request 
enrollment within [insert ``30 days'' or any longer period that applies

[[Page 433]]

under the plan] after your or your dependents' other coverage ends (or 
after the employer stops contributing toward the other coverage).
    In addition, if you have a new dependent as a result of marriage, 
birth, adoption, or placement for adoption, you may be able to enroll 
yourself and your dependents. However, you must request enrollment 
within [insert ``30 days'' or any longer period that applies under the 
plan] after the marriage, birth, adoption, or placement for adoption.
    To request special enrollment or obtain more information, contact 
[insert the name, title, telephone number, and any additional contact 
information of the appropriate plan representative].

    (2) Additional information that may be required. The notice of 
special enrollment must also include, if applicable, the notice 
described in paragraph (a)(3)(iv) of this section (the notice required 
to be furnished to an individual declining coverage if the plan requires 
the reason for declining coverage to be in writing).
    (d) Treatment of special enrollees--(1) If an individual requests 
enrollment while the individual is entitled to special enrollment under 
either paragraph (a) or (b) of this section, the individual is a special 
enrollee, even if the request for enrollment coincides with a late 
enrollment opportunity under the plan. Therefore, the individual cannot 
be treated as a late enrollee.
    (2) Special enrollees must be offered all the benefit packages 
available to similarly situated individuals who enroll when first 
eligible. For this purpose, any difference in benefits or cost-sharing 
requirements for different individuals constitutes a different benefit 
package. In addition, a special enrollee cannot be required to pay more 
for coverage than a similarly situated individual who enrolls in the 
same coverage when first eligible. The length of any preexisting 
condition exclusion that may be applied to a special enrollee cannot 
exceed the length of any preexisting condition exclusion that is applied 
to similarly situated individuals who enroll when first eligible. For 
rules prohibiting the application of a preexisting condition exclusion 
to certain newborns, adopted children, and children placed for adoption, 
see Sec. 54.9801-3(b).
    (3) The rules of this section are illustrated by the following 
example:

    Example 2. (i) Facts. Employer Y maintains a group health plan that 
has an enrollment period for late enrollees every November 1 through 
November 30 with coverage effective the following January 1. On October 
18, Individual B loses coverage under another group health plan and 
satisfies the requirements of paragraphs (a)(2), (3), and (4) of this 
section. B submits a completed application for coverage on November 2.
    (ii) Conclusion. In this Example, B is a special enrollee. 
Therefore, even though B's request for enrollment coincides with an open 
enrollment period, B's coverage is required to be made effective no 
later than December 1 (rather than the plan's January 1 effective date 
for late enrollees).

[T.D. 9166, 69 FR 78746, Dec. 30, 2004]



Sec. 54.9802-1  Prohibiting discrimination against participants and 
beneficiaries based on a health factor.

    (a) Health factors. (1) The term health factor means, in relation to 
an individual, any of the following health status-related factors:
    (i) Health status;
    (ii) Medical condition (including both physical and mental 
illnesses), as defined in Sec. 54.9801-2;
    (iii) Claims experience;
    (iv) Receipt of health care;
    (v) Medical history;
    (vi) Genetic information, as defined in Sec. 54.9802-3T.
    (vii) Evidence of insurability; or
    (viii) Disability.
    (2) Evidence of insurability includes--
    (i) Conditions arising out of acts of domestic violence; and
    (ii) Participation in activities such as motorcycling, snowmobiling, 
all-terrain vehicle riding, horseback riding, skiing, and other similar 
activities.
    (3) The decision whether health coverage is elected for an 
individual (including the time chosen to enroll, such as under special 
enrollment or late enrollment) is not, itself, within the scope of any 
health factor. (However, under Sec. 54.9801-6, a plan must treat 
special enrollees the same as similarly situated individuals who are 
enrolled when first eligible.)
    (b) Prohibited discrimination in rules for eligibility--(1) In 
general. (i) A group health plan may not establish any rule for 
eligibility (including continued eligibility) of any individual to 
enroll for benefits under the terms of the plan

[[Page 434]]

that discriminates based on any health factor that relates to that 
individual or a dependent of that individual. This rule is subject to 
the provisions of paragraph (b)(2) of this section (explaining how this 
rule applies to benefits), paragraph (b)(3) of this section (allowing 
plans to impose certain preexisting condition exclusions), paragraph (d) 
of this section (containing rules for establishing groups of similarly 
situated individuals), paragraph (e) of this section (relating to 
nonconfinement, actively-at-work, and other service requirements), 
paragraph (f) of this section (relating to wellness programs), and 
paragraph (g) of this section (permitting favorable treatment of 
individuals with adverse health factors).
    (ii) For purposes of this section, rules for eligibility include, 
but are not limited to, rules relating to--
    (A) Enrollment;
    (B) The effective date of coverage;
    (C) Waiting (or affiliation) periods;
    (D) Late and special enrollment;
    (E) Eligibility for benefit packages (including rules for 
individuals to change their selection among benefit packages);
    (F) Benefits (including rules relating to covered benefits, benefit 
restrictions, and cost-sharing mechanisms such as coinsurance, 
copayments, and deductibles), as described in paragraphs (b)(2) and (3) 
of this section;
    (G) Continued eligibility; and
    (H) Terminating coverage (including disenrollment) of any individual 
under the plan.
    (iii) The rules of this paragraph (b)(1) are illustrated by the 
following examples:

    Example 1. (i) Facts. An employer sponsors a group health plan that 
is available to all employees who enroll within the first 30 days of 
their employment. However, employees who do not enroll within the first 
30 days cannot enroll later unless they pass a physical examination.
    (ii) Conclusion. In this Example 1, the requirement to pass a 
physical examination in order to enroll in the plan is a rule for 
eligibility that discriminates based on one or more health factors and 
thus violates this paragraph (b)(1).
    Example 2. (i) Facts. Under an employer's group health plan, 
employees who enroll during the first 30 days of employment (and during 
special enrollment periods) may choose between two benefit packages: An 
indemnity option and an HMO option. However, employees who enroll during 
late enrollment are permitted to enroll only in the HMO option and only 
if they provide evidence of good health.
    (ii) Conclusion. In this Example 2, the requirement to provide 
evidence of good health in order to be eligible for late enrollment in 
the HMO option is a rule for eligibility that discriminates based on one 
or more health factors and thus violates this paragraph (b)(1). However, 
if the plan did not require evidence of good health but limited late 
enrollees to the HMO option, the plan's rules for eligibility would not 
discriminate based on any health factor, and thus would not violate this 
paragraph (b)(1), because the time an individual chooses to enroll is 
not, itself, within the scope of any health factor.
    Example 3. (i) Facts. Under an employer's group health plan, all 
employees generally may enroll within the first 30 days of employment. 
However, individuals who participate in certain recreational activities, 
including motorcycling, are excluded from coverage.
    (ii) Conclusion. In this Example 3, excluding from the plan 
individuals who participate in recreational activities, such as 
motorcycling, is a rule for eligibility that discriminates based on one 
or more health factors and thus violates this paragraph (b)(1).
    Example 4. (i) Facts. A group health plan applies for a group health 
policy offered by an issuer. As part of the application, the issuer 
receives health information about individuals to be covered under the 
plan. Individual A is an employee of the employer maintaining the plan. 
A and A's dependents have a history of high health claims. Based on the 
information about A and A's dependents, the issuer excludes A and A's 
dependents from the group policy it offers to the employer.
    (ii) Conclusion. See Example 4 in 29 CFR 2590.702(b)(1) and 45 CFR 
146.121(b)(1) for a conclusion that the exclusion by the issuer of A and 
A's dependents from coverage is a rule for eligibility that 
discriminates based on one or more health factors and violates rules 
under 29 CFR 2590.702(b)(1) and 45 CFR 146.121(b)(1) similar to the 
rules under this paragraph (b)(1). (If the employer is a small employer 
under 45 CFR 144.103 (generally, an employer with 50 or fewer 
employees), the issuer also may violate 45 CFR 146.150, which requires 
issuers to offer all the policies they sell in the small group market on 
a guaranteed available basis to all small employers and to accept every 
eligible individual in every small employer group.) If the plan provides 
coverage through this policy and does not provide equivalent coverage 
for A and A's dependents through other means, the plan violates this 
paragraph (b)(1).


[[Page 435]]


    (2) Application to benefits--(i) General rule--(A) Under this 
section, a group health plan is not required to provide coverage for any 
particular benefit to any group of similarly situated individuals.
    (B) However, benefits provided under a plan must be uniformly 
available to all similarly situated individuals (as described in 
paragraph (d) of this section). Likewise, any restriction on a benefit 
or benefits must apply uniformly to all similarly situated individuals 
and must not be directed at individual participants or beneficiaries 
based on any health factor of the participants or beneficiaries 
(determined based on all the relevant facts and circumstances). Thus, 
for example, a plan may limit or exclude benefits in relation to a 
specific disease or condition, limit or exclude benefits for certain 
types of treatments or drugs, or limit or exclude benefits based on a 
determination of whether the benefits are experimental or not medically 
necessary, but only if the benefit limitation or exclusion applies 
uniformly to all similarly situated individuals and is not directed at 
individual participants or beneficiaries based on any health factor of 
the participants or beneficiaries. In addition, a plan may impose 
annual, lifetime, or other limits on benefits and may require the 
satisfaction of a deductible, copayment, coinsurance, or other cost-
sharing requirement in order to obtain a benefit if the limit or cost-
sharing requirement applies uniformly to all similarly situated 
individuals and is not directed at individual participants or 
beneficiaries based on any health factor of the participants or 
beneficiaries. In the case of a cost-sharing requirement, see also 
paragraph (b)(2)(ii) of this section, which permits variances in the 
application of a cost-sharing mechanism made available under a wellness 
program. (Whether any plan provision or practice with respect to 
benefits complies with this paragraph (b)(2)(i) does not affect whether 
the provision or practice is permitted under ERISA, the Americans with 
Disabilities Act, or any other law, whether State or Federal.)
    (C) For purposes of this paragraph (b)(2)(i), a plan amendment 
applicable to all individuals in one or more groups of similarly 
situated individuals under the plan and made effective no earlier than 
the first day of the first plan year after the amendment is adopted is 
not considered to be directed at any individual participants or 
beneficiaries.
    (D) The rules of this paragraph (b)(2)(i) are illustrated by the 
following examples:

    Example 1. (i) Facts. A group health plan applies a $500,000 
lifetime limit on all benefits to each participant or beneficiary 
covered under the plan. The limit is not directed at individual 
participants or beneficiaries.
    (ii) Conclusion. In this Example 1, the limit does not violate this 
paragraph (b)(2)(i) because $500,000 of benefits are available uniformly 
to each participant and beneficiary under the plan and because the limit 
is applied uniformly to all participants and beneficiaries and is not 
directed at individual participants or beneficiaries.
    Example 2. (i) Facts. A group health plan has a $2 million lifetime 
limit on all benefits (and no other lifetime limits) for participants 
covered under the plan. Participant B files a claim for the treatment of 
AIDS. At the next corporate board meeting of the plan sponsor, the claim 
is discussed. Shortly thereafter, the plan is modified to impose a 
$10,000 lifetime limit on benefits for the treatment of AIDS, effective 
before the beginning of the next plan year.
    (ii) Conclusion. The facts of this Example 2 strongly suggest that 
the plan modification is directed at B based on B's claim. Absent 
outweighing evidence to the contrary, the plan violates this paragraph 
(b)(2)(i).
    Example 3. (i) A group health plan applies for a group health policy 
offered by an issuer. Individual C is covered under the plan and has an 
adverse health condition. As part of the application, the issuer 
receives health information about the individuals to be covered, 
including information about C's adverse health condition. The policy 
form offered by the issuer generally provides benefits for the adverse 
health condition that C has, but in this case the issuer offers the plan 
a policy modified by a rider that excludes benefits for C for that 
condition. The exclusionary rider is made effective the first day of the 
next plan year.
    (ii) Conclusion. See Example 3 in 29 CFR 2590.702(b)(2)(i) and 45 
CFR 146.121(b)(2)(i) for a conclusion that the issuer violates rules 
under 29 CFR 2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i) similar to 
the rules under this paragraph (b)(2)(i) because benefits for C's 
condition are available to other individuals in the group of similarly 
situated individuals that includes C but are not available to C. Thus, 
the benefits are not uniformly available to all similarly situated 
individuals.

[[Page 436]]

Even though the exclusionary rider is made effective the first day of 
the next plan year, because the rider does not apply to all similarly 
situated individuals, the issuer violates the rules under 29 CFR 
2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i). If the plan provides 
coverage through this policy and does not provide equivalent coverage 
for C through other means, the plan violates this paragraph (b)(2)(i).
    Example 4. (i) Facts. A group health plan has a $2,000 lifetime 
limit for the treatment of temporomandibular joint syndrome (TMJ). The 
limit is applied uniformly to all similarly situated individuals and is 
not directed at individual participants or beneficiaries.
    (ii) Conclusion. In this Example 4, the limit does not violate this 
paragraph (b)(2)(i) because $2,000 of benefits for the treatment of TMJ 
are available uniformly to all similarly situated individuals and a plan 
may limit benefits covered in relation to a specific disease or 
condition if the limit applies uniformly to all similarly situated 
individuals and is not directed at individual participants or 
beneficiaries. (This example does not address whether the plan provision 
is permissible under the Americans with Disabilities Act or any other 
applicable law.)
    Example 5. (i) Facts. A group health plan applies a $2 million 
lifetime limit on all benefits. However, the $2 million lifetime limit 
is reduced to $10,000 for any participant or beneficiary covered under 
the plan who has a congenital heart defect.
    (ii) Conclusion. In this Example 5, the lower lifetime limit for 
participants and beneficiaries with a congenital heart defect violates 
this paragraph (b)(2)(i) because benefits under the plan are not 
uniformly available to all similarly situated individuals and the plan's 
lifetime limit on benefits does not apply uniformly to all similarly 
situated individuals.
    Example 6. (i) Facts. A group health plan limits benefits for 
prescription drugs to those listed on a drug formulary. The limit is 
applied uniformly to all similarly situated individuals and is not 
directed at individual participants or beneficiaries.
    (ii) Conclusion. In this Example 6, the exclusion from coverage of 
drugs not listed on the drug formulary does not violate this paragraph 
(b)(2)(i) because benefits for prescription drugs listed on the 
formulary are uniformly available to all similarly situated individuals 
and because the exclusion of drugs not listed on the formulary applies 
uniformly to all similarly situated individuals and is not directed at 
individual participants or beneficiaries.
    Example 7. (i) Facts. Under a group health plan, doctor visits are 
generally subject to a $250 annual deductible and 20 percent coinsurance 
requirement. However, prenatal doctor visits are not subject to any 
deductible or coinsurance requirement. These rules are applied uniformly 
to all similarly situated individuals and are not directed at individual 
participants or beneficiaries.
    (ii) Conclusion. In this Example 7, imposing different deductible 
and coinsurance requirements for prenatal doctor visits and other visits 
does not violate this paragraph (b)(2)(i) because a plan may establish 
different deductibles or coinsurance requirements for different services 
if the deductible or coinsurance requirement is applied uniformly to all 
similarly situated individuals and is not directed at individual 
participants or beneficiaries.
    Example 8. (i) Facts. An employer sponsors a group health plan that 
is available to all current employees. Under the plan, the medical care 
expenses of each employee (and the employee's dependents) are reimbursed 
up to an annual maximum amount. The maximum reimbursement amount with 
respect to an employee for a year is $1500 multiplied by the number of 
years the employee has participated in the plan, reduced by the total 
reimbursements for prior years.
    (ii) Conclusion. In this Example 8, the variable annual limit does 
not violate this paragraph (b)(2)(i). Although the maximum reimbursement 
amount for a year varies among employees within the same group of 
similarly situated individuals based on prior claims experience, 
employees who have participated in the plan for the same length of time 
are eligible for the same total benefit over that length of time (and 
the restriction on the maximum reimbursement amount is not directed at 
any individual participants or beneficiaries based on any health 
factor).

    (ii) Exception for wellness programs. A group health plan may vary 
benefits, including cost-sharing mechanisms (such as a deductible, 
copayment, or coinsurance), based on whether an individual has met the 
standards of a wellness program that satisfies the requirements of 
paragraph (f) of this section.
    (iii) Specific rule relating to source-of-injury exclusions--(A) If 
a group health plan generally provides benefits for a type of injury, 
the plan may not deny benefits otherwise provided for treatment of the 
injury if the injury results from an act of domestic violence or a 
medical condition (including both physical and mental health 
conditions). This rule applies in the case of an injury resulting from a 
medical condition even if the condition is not diagnosed before the 
injury.

[[Page 437]]

    (B) The rules of this paragraph (b)(2)(iii) are illustrated by the 
following examples:

    Example 1. (i) Facts. A group health plan generally provides 
medical/surgical benefits, including benefits for hospital stays, that 
are medically necessary. However, the plan excludes benefits for self-
inflicted injuries or injuries sustained in connection with attempted 
suicide. Because of depression, Individual D attempts suicide. As a 
result, D sustains injuries and is hospitalized for treatment of the 
injuries. Under the exclusion, the plan denies D benefits for treatment 
of the injuries.
    (ii) Conclusion. In this Example 1, the suicide attempt is the 
result of a medical condition (depression). Accordingly, the denial of 
benefits for the treatments of D's injuries violates the requirements of 
this paragraph (b)(2)(iii) because the plan provision excludes benefits 
for treatment of an injury resulting from a medical condition.
    Example 2. (i) Facts. A group health plan provides benefits for head 
injuries generally. The plan also has a general exclusion for any injury 
sustained while participating in any of a number of recreational 
activities, including bungee jumping. However, this exclusion does not 
apply to any injury that results from a medical condition (nor from 
domestic violence). Participant E sustains a head injury while bungee 
jumping. The injury did not result from a medical condition (nor from 
domestic violence). Accordingly, the plan denies benefits for E's head 
injury.
    (ii) Conclusion. In this Example 2, the plan provision that denies 
benefits based on the source of an injury does not restrict benefits 
based on an act of domestic violence or any medical condition. 
Therefore, the provision is permissible under this paragraph (b)(2)(iii) 
and does not violate this section. (However, if the plan did not allow E 
to enroll in the plan (or applied different rules for eligibility to E) 
because E frequently participates in bungee jumping, the plan would 
violate paragraph (b)(1) of this section.)

    (3) Relationship to Sec. 54.9801-3. (i) A preexisting condition 
exclusion is permitted under this section if it--
    (A) Complies with Sec. 54.9801-3;
    (B) Applies uniformly to all similarly situated individuals (as 
described in paragraph (d) of this section); and
    (C) Is not directed at individual participants or beneficiaries 
based on any health factor of the participants or beneficiaries. For 
purposes of this paragraph (b)(3)(i)(C), a plan amendment relating to a 
preexisting condition exclusion applicable to all individuals in one or 
more groups of similarly situated individuals under the plan and made 
effective no earlier than the first day of the first plan year after the 
amendment is adopted is not considered to be directed at any individual 
participants or beneficiaries.
    (ii) The rules of this paragraph (b)(3) are illustrated by the 
following examples:

    Example 1. (i) Facts. A group health plan imposes a preexisting 
condition exclusion on all individuals enrolled in the plan. The 
exclusion applies to conditions for which medical advice, diagnosis, 
care, or treatment was recommended or received within the six-month 
period ending on an individual's enrollment date. In addition, the 
exclusion generally extends for 12 months after an individual's 
enrollment date, but this 12-month period is offset by the number of 
days of an individual's creditable coverage in accordance with Sec. 
54.9801-3. There is nothing to indicate that the exclusion is directed 
at individual participants or beneficiaries.
    (ii) Conclusion. In this Example 1, even though the plan's 
preexisting condition exclusion discriminates against individuals based 
on one or more health factors, the preexisting condition exclusion does 
not violate this section because it applies uniformly to all similarly 
situated individuals, is not directed at individual participants or 
beneficiaries, and complies with Sec. 54.9801-3 (that is, the 
requirements relating to the six-month look-back period, the 12-month 
(or 18-month) maximum exclusion period, and the creditable coverage 
offset).
    Example 2. (i) Facts. A group health plan excludes coverage for 
conditions with respect to which medical advice, diagnosis, care, or 
treatment was recommended or received within the six-month period ending 
on an individual's enrollment date. Under the plan, the preexisting 
condition exclusion generally extends for 12 months, offset by 
creditable coverage. However, if an individual has no claims in the 
first six months following enrollment, the remainder of the exclusion 
period is waived.
    (ii) Conclusion. In this Example 2, the plan's preexisting condition 
exclusions violate this section because they do not meet the 
requirements of this paragraph (b)(3); specifically, they do not apply 
uniformly to all similarly situated individuals. The plan provisions do 
not apply uniformly to all similarly situated individuals because 
individuals who have medical claims during the first six months 
following enrollment are not treated the same as similarly situated 
individuals with no claims during that period. (Under paragraph (d) of 
this section, the groups cannot be treated as two separate

[[Page 438]]

groups of similarly situated individuals because the distinction is 
based on a health factor.)

    (c) Prohibited discrimination in premiums or contributions--(1) In 
general--(i) A group health plan may not require an individual, as a 
condition of enrollment or continued enrollment under the plan, to pay a 
premium or contribution that is greater than the premium or contribution 
for a similarly situated individual (described in paragraph (d) of this 
section) enrolled in the plan based on any health factor that relates to 
the individual or a dependent of the individual.
    (ii) Discounts, rebates, payments in kind, and any other premium 
differential mechanisms are taken into account in determining an 
individual's premium or contribution rate. (For rules relating to cost-
sharing mechanisms, see paragraph (b)(2) of this section (addressing 
benefits).)
    (2) Rules relating to premium rates--(i) Group rating based on 
health factors not restricted under this section. Nothing in this 
section restricts the aggregate amount that an employer may be charged 
for coverage under a group health plan. But see Sec. 54.9802-3T(b), 
which prohibits adjustments in group premium or contribution rates based 
on genetic information.
    (ii) List billing based on a health factor prohibited. However, a 
group health plan may not quote or charge an employer (or an individual) 
a different premium for an individual in a group of similarly situated 
individuals based on a health factor. (But see paragraph (g) of this 
section permitting favorable treatment of individuals with adverse 
health factors.)
    (iii) Examples. The rules of this paragraph (c)(2) are illustrated 
by the following examples:

    Example 1. (i) Facts. An employer sponsors a group health plan and 
purchases coverage from a health insurance issuer. In order to determine 
the premium rate for the upcoming plan year, the issuer reviews the 
claims experience of individuals covered under the plan. The issuer 
finds that Individual F had significantly higher claims experience than 
similarly situated individuals in the plan. The issuer quotes the plan a 
higher per-participant rate because of F's claims experience.
    (ii) Conclusion. See Example 1 in 29 CFR 2590.702(c)(2) and 45 CFR 
146.121(c)(2) for a conclusion that the issuer does not violate the 
provisions of 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) similar to 
the provisions of this paragraph (c)(2) because the issuer blends the 
rate so that the employer is not quoted a higher rate for F than for a 
similarly situated individual based on F's claims experience. (However, 
those examples conclude that if the issuer used genetic information in 
computing the group rate, it would violate 29 CFR 2590.702-1(b) or 45 
CFR 146.122(b).)
    Example 2. (i) Facts. Same facts as Example 1, except that the 
issuer quotes the employer a higher premium rate for F, because of F's 
claims experience, than for a similarly situated individual.
    (ii) Conclusion. See Example 2 in 29 CFR 2590.702(c)(2) and 45 CFR 
146.121(c)(2) for a conclusion that the issuer violates provisions of 29 
CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) similar to the provisions of 
this paragraph (c)(2). Moreover, even if the plan purchased the policy 
based on the quote but did not require a higher participant contribution 
for F than for a similarly situated individual, see Example 2 in 29 CFR 
2590.702(c)(2) and 45 CFR 146.121(c)(2) for a conclusion that the issuer 
would still violate 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) (but 
in such a case the plan would not violate this paragraph (c)(2)).

    (3) Exception for wellness programs. Notwithstanding paragraphs 
(c)(1) and (2) of this section, a plan may vary the amount of premium or 
contribution it requires similarly situated individuals to pay based on 
whether an individual has met the standards of a wellness program that 
satisfies the requirements of paragraph (f) of this section.
    (d) Similarly situated individuals. The requirements of this section 
apply only within a group of individuals who are treated as similarly 
situated individuals. A plan may treat participants as a group of 
similarly situated individuals separate from beneficiaries. In addition, 
participants may be treated as two or more distinct groups of similarly 
situated individuals and beneficiaries may be treated as two or more 
distinct groups of similarly situated individuals in accordance with the 
rules of this paragraph (d). Moreover, if individuals have a choice of 
two or more benefit packages, individuals choosing one benefit package 
may be treated as one or more groups of similarly situated individuals 
distinct from individuals choosing another benefit package.

[[Page 439]]

    (1) Participants. Subject to paragraph (d)(3) of this section, a 
plan may treat participants as two or more distinct groups of similarly 
situated individuals if the distinction between or among the groups of 
participants is based on a bona fide employment-based classification 
consistent with the employer's usual business practice. Whether an 
employment-based classification is bona fide is determined on the basis 
of all the relevant facts and circumstances. Relevant facts and 
circumstances include whether the employer uses the classification for 
purposes independent of qualification for health coverage (for example, 
determining eligibility for other employee benefits or determining other 
terms of employment). Subject to paragraph (d)(3) of this section, 
examples of classifications that, based on all the relevant facts and 
circumstances, may be bona fide include full-time versus part-time 
status, different geographic location, membership in a collective 
bargaining unit, date of hire, length of service, current employee 
versus former employee status, and different occupations. However, a 
classification based on any health factor is not a bona fide employment-
based classification, unless the requirements of paragraph (g) of this 
section are satisfied (permitting favorable treatment of individuals 
with adverse health factors).
    (2) Beneficiaries--(i) Subject to paragraph (d)(3) of this section, 
a plan may treat beneficiaries as two or more distinct groups of 
similarly situated individuals if the distinction between or among the 
groups of beneficiaries is based on any of the following factors:
    (A) A bona fide employment-based classification of the participant 
through whom the beneficiary is receiving coverage;
    (B) Relationship to the participant (for example, as a spouse or as 
a dependent child);
    (C) Marital status;
    (D) With respect to children of a participant, age or student 
status; or
    (E) Any other factor if the factor is not a health factor.
    (ii) Paragraph (d)(2)(i) of this section does not prevent more 
favorable treatment of individuals with adverse health factors in 
accordance with paragraph (g) of this section.
    (3) Discrimination directed at individuals. Notwithstanding 
paragraphs (d)(1) and (2) of this section, if the creation or 
modification of an employment or coverage classification is directed at 
individual participants or beneficiaries based on any health factor of 
the participants or beneficiaries, the classification is not permitted 
under this paragraph (d), unless it is permitted under paragraph (g) of 
this section (permitting favorable treatment of individuals with adverse 
health factors). Thus, if an employer modified an employment-based 
classification to single out, based on a health factor, individual 
participants and beneficiaries and deny them health coverage, the new 
classification would not be permitted under this section.
    (4) Examples. The rules of this paragraph (d) are illustrated by the 
following examples:

    Example 1. (i) Facts. An employer sponsors a group health plan for 
full-time employees only. Under the plan (consistent with the employer's 
usual business practice), employees who normally work at least 30 hours 
per week are considered to be working full-time. Other employees are 
considered to be working part-time. There is no evidence to suggest that 
the classification is directed at individual participants or 
beneficiaries.
    (ii) Conclusion. In this Example 1, treating the full-time and part-
time employees as two separate groups of similarly situated individuals 
is permitted under this paragraph (d) because the classification is bona 
fide and is not directed at individual participants or beneficiaries.
    Example 2. (i) Facts. Under a group health plan, coverage is made 
available to employees, their spouses, and their dependent children. 
However, coverage is made available to a dependent child only if the 
dependent child is under age 19 (or under age 25 if the child is 
continuously enrolled full-time in an institution of higher learning 
(full-time students)). There is no evidence to suggest that these 
classifications are directed at individual participants or 
beneficiaries.
    (ii) Conclusion. In this Example 2, treating spouses and dependent 
children differently by imposing an age limitation on dependent 
children, but not on spouses, is permitted under this paragraph (d). 
Specifically, the distinction between spouses and dependent children is 
permitted under paragraph (d)(2) of this section and is not prohibited 
under paragraph (d)(3) of this section because it is not directed at 
individual participants or

[[Page 440]]

beneficiaries. It is also permissible to treat dependent children who 
are under age 19 (or full-time students under age 25) as a group of 
similarly situated individuals separate from those who are age 25 or 
older (or age 19 or older if they are not full-time students) because 
the classification is permitted under paragraph (d)(2) of this section 
and is not directed at individual participants or beneficiaries.
    Example 3. (i) Facts. A university sponsors a group health plan that 
provides one health benefit package to faculty and another health 
benefit package to other staff. Faculty and staff are treated 
differently with respect to other employee benefits such as retirement 
benefits and leaves of absence. There is no evidence to suggest that the 
distinction is directed at individual participants or beneficiaries.
    (ii) Conclusion. In this Example 3, the classification is permitted 
under this paragraph (d) because there is a distinction based on a bona 
fide employment-based classification consistent with the employer's 
usual business practice and the distinction is not directed at 
individual participants and beneficiaries.
    Example 4. (i) Facts. An employer sponsors a group health plan that 
is available to all current employees. Former employees may also be 
eligible, but only if they complete a specified number of years of 
service, are enrolled under the plan at the time of termination of 
employment, and are continuously enrolled from that date. There is no 
evidence to suggest that these distinctions are directed at individual 
participants or beneficiaries.
    (ii) Conclusion. In this Example 4, imposing additional eligibility 
requirements on former employees is permitted because a classification 
that distinguishes between current and former employees is a bona fide 
employment-based classification that is permitted under this paragraph 
(d), provided that it is not directed at individual participants or 
beneficiaries. In addition, it is permissible to distinguish between 
former employees who satisfy the service requirement and those who do 
not, provided that the distinction is not directed at individual 
participants or beneficiaries. (However, former employees who do not 
satisfy the eligibility criteria may, nonetheless, be eligible for 
continued coverage pursuant to a COBRA continuation provision or similar 
State law.)
    Example 5. (i) Facts. An employer sponsors a group health plan that 
provides the same benefit package to all seven employees of the 
employer. Six of the seven employees have the same job title and 
responsibilities, but Employee G has a different job title and different 
responsibilities. After G files an expensive claim for benefits under 
the plan, coverage under the plan is modified so that employees with G's 
job title receive a different benefit package that includes a lower 
lifetime dollar limit than in the benefit package made available to the 
other six employees.
    (ii) Conclusion. Under the facts of this Example 5, changing the 
coverage classification for G based on the existing employment 
classification for G is not permitted under this paragraph (d) because 
the creation of the new coverage classification for G is directed at G 
based on one or more health factors.

    (e) Nonconfinement and actively-at-work provisions--(1) 
Nonconfinement provisions--(i) General rule. Under the rules of 
paragraphs (b) and (c) of this section, a plan may not establish a rule 
for eligibility (as described in paragraph (b)(1)(ii) of this section) 
or set any individual's premium or contribution rate based on whether an 
individual is confined to a hospital or other health care institution. 
In addition, under the rules of paragraphs (b) and (c) of this section, 
a plan may not establish a rule for eligibility or set any individual's 
premium or contribution rate based on an individual's ability to engage 
in normal life activities, except to the extent permitted under 
paragraphs (e)(2)(ii) and (3) of this section (permitting plans, under 
certain circumstances, to distinguish among employees based on the 
performance of services).
    (ii) Examples. The rules of this paragraph (e)(1) are illustrated by 
the following examples:

    Example 1. (i) Facts. Under a group health plan, coverage for 
employees and their dependents generally becomes effective on the first 
day of employment. However, coverage for a dependent who is confined to 
a hospital or other health care institution does not become effective 
until the confinement ends.
    (ii) Conclusion. In this Example 1, the plan violates this paragraph 
(e)(1) because the plan delays the effective date of coverage for 
dependents based on confinement to a hospital or other health care 
institution.
    Example 2. (i) Facts. In previous years, a group health plan has 
provided coverage through a group health insurance policy offered by 
Issuer M. However, for the current year, the plan provides coverage 
through a group health insurance policy offered by Issuer N. Under 
Issuer N's policy, items and services provided in connection with the 
confinement of a dependent to a hospital or other health care 
institution are not covered if the confinement is covered under an 
extension of benefits clause from a previous health insurance issuer.

[[Page 441]]

    (ii) Conclusion. See Example 2 in 29 CFR 2590.702(e)(1) and 45 CFR 
146.121(e)(1) for a conclusion that Issuer N violates provisions of 29 
CFR 2590.702(e)(1) and 45 CFR 146.121(e)(1) similar to the provisions of 
this paragraph (e)(1) because the group health insurance coverage 
restricts benefits based on whether a dependent is confined to a 
hospital or other health care institution that is covered under an 
extension of benefits from a previous issuer. See Example 2 in 29 CFR 
2590.702(e)(1) and 45 CFR 146.121(e)(1) for the additional conclusions 
that under State law Issuer M may also be responsible for providing 
benefits to such a dependent; and that in a case in which Issuer N has 
an obligation under 29 CFR 2590.702(e)(1) or 45 CFR 146.121(e)(1) to 
provide benefits and Issuer M has an obligation under State law to 
provide benefits, any State laws designed to prevent more than 100% 
reimbursement, such as State coordination-of-benefits laws, continue to 
apply.

    (2) Actively-at-work and continuous service provisions--(i) General 
rule--(A) Under the rules of paragraphs (b) and (c) of this section and 
subject to the exception for the first day of work described in 
paragraph (e)(2)(ii) of this section, a plan may not establish a rule 
for eligibility (as described in paragraph (b)(1)(ii) of this section) 
or set any individual's premium or contribution rate based on whether an 
individual is actively at work (including whether an individual is 
continuously employed), unless absence from work due to any health 
factor (such as being absent from work on sick leave) is treated, for 
purposes of the plan, as being actively at work.
    (B) The rules of this paragraph (e)(2)(i) are illustrated by the 
following examples:

    Example 1. (i) Facts. Under a group health plan, an employee 
generally becomes eligible to enroll 30 days after the first day of 
employment. However, if the employee is not actively at work on the 
first day after the end of the 30-day period, then eligibility for 
enrollment is delayed until the first day the employee is actively at 
work.
    (ii) Conclusion. In this Example 1, the plan violates this paragraph 
(e)(2) (and thus also violates paragraph (b) of this section). However, 
the plan would not violate paragraph (e)(2) or (b) of this section if, 
under the plan, an absence due to any health factor is considered being 
actively at work.
    Example 2. (i) Facts. Under a group health plan, coverage for an 
employee becomes effective after 90 days of continuous service; that is, 
if an employee is absent from work (for any reason) before completing 90 
days of service, the beginning of the 90-day period is measured from the 
day the employee returns to work (without any credit for service before 
the absence).
    (ii) Conclusion. In this Example 2, the plan violates this paragraph 
(e)(2) (and thus also paragraph (b) of this section) because the 90-day 
continuous service requirement is a rule for eligibility based on 
whether an individual is actively at work. However, the plan would not 
violate this paragraph (e)(2) or paragraph (b) of this section if, under 
the plan, an absence due to any health factor is not considered an 
absence for purposes of measuring 90 days of continuous service.

    (ii) Exception for the first day of work--(A) Notwithstanding the 
general rule in paragraph (e)(2)(i) of this section, a plan may 
establish a rule for eligibility that requires an individual to begin 
work for the employer sponsoring the plan (or, in the case of a 
multiemployer plan, to begin a job in covered employment) before 
coverage becomes effective, provided that such a rule for eligibility 
applies regardless of the reason for the absence.
    (B) The rules of this paragraph (e)(2)(ii) are illustrated by the 
following examples:

    Example 1. (i) Facts. Under the eligibility provision of a group 
health plan, coverage for new employees becomes effective on the first 
day that the employee reports to work. Individual H is scheduled to 
begin work on August 3. However, H is unable to begin work on that day 
because of illness. H begins working on August 4, and H's coverage is 
effective on August 4.
    (ii) Conclusion. In this Example 1, the plan provision does not 
violate this section. However, if coverage for individuals who do not 
report to work on the first day they were scheduled to work for a reason 
unrelated to a health factor (such as vacation or bereavement) becomes 
effective on the first day they were scheduled to work, then the plan 
would violate this section.
    Example 2. (i) Facts. Under a group health plan, coverage for new 
employees becomes effective on the first day of the month following the 
employee's first day of work, regardless of whether the employee is 
actively at work on the first day of the month. Individual J is 
scheduled to begin work on March 24. However, J is unable to begin work 
on March 24 because of illness. J begins working on April 7 and J's 
coverage is effective May 1.
    (ii) Conclusion. In this Example 2, the plan provision does not 
violate this section. However, as in Example 1, if coverage for 
individuals absent from work for reasons unrelated

[[Page 442]]

to a health factor became effective despite their absence, then the plan 
would violate this section.

    (3) Relationship to plan provisions defining similarly situated 
individuals--(i) Notwithstanding the rules of paragraphs (e)(1) and (2) 
of this section, a plan may establish rules for eligibility or set any 
individual's premium or contribution rate in accordance with the rules 
relating to similarly situated individuals in paragraph (d) of this 
section. Accordingly, a plan may distinguish in rules for eligibility 
under the plan between full-time and part-time employees, between 
permanent and temporary or seasonal employees, between current and 
former employees, and between employees currently performing services 
and employees no longer performing services for the employer, subject to 
paragraph (d) of this section. However, other Federal or State laws 
(including the COBRA continuation provisions and the Family and Medical 
Leave Act of 1993) may require an employee or the employee's dependents 
to be offered coverage and set limits on the premium or contribution 
rate even though the employee is not performing services.
    (ii) The rules of this paragraph (e)(3) are illustrated by the 
following examples:

    Example 1. (i) Facts. Under a group health plan, employees are 
eligible for coverage if they perform services for the employer for 30 
or more hours per week or if they are on paid leave (such as vacation, 
sick, or bereavement leave). Employees on unpaid leave are treated as a 
separate group of similarly situated individuals in accordance with the 
rules of paragraph (d) of this section.
    (ii) Conclusion. In this Example 1, the plan provisions do not 
violate this section. However, if the plan treated individuals 
performing services for the employer for 30 or more hours per week, 
individuals on vacation leave, and individuals on bereavement leave as a 
group of similarly situated individuals separate from individuals on 
sick leave, the plan would violate this paragraph (e) (and thus also 
would violate paragraph (b) of this section) because groups of similarly 
situated individuals cannot be established based on a health factor 
(including the taking of sick leave) under paragraph (d) of this 
section.
    Example 2. (i) Facts. To be eligible for coverage under a bona fide 
collectively bargained group health plan in the current calendar 
quarter, the plan requires an individual to have worked 250 hours in 
covered employment during the three-month period that ends one month 
before the beginning of the current calendar quarter. The distinction 
between employees working at least 250 hours and those working less than 
250 hours in the earlier three-month period is not directed at 
individual participants or beneficiaries based on any health factor of 
the participants or beneficiaries.
    (ii) Conclusion. In this Example 2, the plan provision does not 
violate this section because, under the rules for similarly situated 
individuals allowing full-time employees to be treated differently than 
part-time employees, employees who work at least 250 hours in a three-
month period can be treated differently than employees who fail to work 
250 hours in that period. The result would be the same if the plan 
permitted individuals to apply excess hours from previous periods to 
satisfy the requirement for the current quarter.
    Example 3. (i) Facts. Under a group health plan, coverage of an 
employee is terminated when the individual's employment is terminated, 
in accordance with the rules of paragraph (d) of this section. Employee 
B has been covered under the plan. B experiences a disabling illness 
that prevents B from working. B takes a leave of absence under the 
Family and Medical Leave Act of 1993. At the end of such leave, B 
terminates employment and consequently loses coverage under the plan. 
(This termination of coverage is without regard to whatever rights the 
employee (or members of the employee's family) may have for COBRA 
continuation.)
    (ii) Conclusion. In this Example 3, the plan provision terminating 
B's coverage upon B's termination of employment does not violate this 
section.
    Example 4. (i) Facts. Under a group health plan, coverage of an 
employee is terminated when the employee ceases to perform services for 
the employer sponsoring the plan, in accordance with the rules of 
paragraph (d) of this section. Employee C is laid off for three months. 
When the layoff begins, C's coverage under the plan is terminated. (This 
termination of coverage is without regard to whatever rights the 
employee (or members of the employee's family) may have for COBRA 
continuation coverage.)
    (ii) Conclusion. In this Example 4, the plan provision terminating 
C's coverage upon the cessation of C's performance of services does not 
violate this section.

    (f) Wellness programs. A wellness program is any program designed to 
promote health or prevent disease. Paragraphs (b)(2)(ii) and (c)(3) of 
this section provide exceptions to the general prohibitions against 
discrimination

[[Page 443]]

based on a health factor for plan provisions that vary benefits 
(including cost-sharing mechanisms) or the premium or contribution for 
similarly situated individuals in connection with a wellness program 
that satisfies the requirements of this paragraph (f). If none of the 
conditions for obtaining a reward under a wellness program is based on 
an individual satisfying a standard that is related to a health factor, 
paragraph (f)(1) of this section clarifies that the wellness program 
does not violate this section if participation in the program is made 
available to all similarly situated individuals. If any of the 
conditions for obtaining a reward under a wellness program is based on 
an individual satisfying a standard that is related to a health factor, 
the wellness program does not violate this section if the requirements 
of paragraph (f)(2) of this section are met.
    (1) Wellness programs not subject to requirements. If none of the 
conditions for obtaining a reward under a wellness program are based on 
an individual satisfying a standard that is related to a health factor 
(or if a wellness program does not provide a reward), the wellness 
program does not violate this section, if participation in the program 
is made available to all similarly situated individuals. Thus, for 
example, the following programs need not satisfy the requirements of 
paragraph (f)(2) of this section, if participation in the program is 
made available to all similarly situated individuals:
    (i) A program that reimburses all or part of the cost for 
memberships in a fitness center.
    (ii) A diagnostic testing program that provides a reward for 
participation and does not base any part of the reward on outcomes.
    (iii) A program that encourages preventive care through the waiver 
of the copayment or deductible requirement under a group health plan for 
the costs of, for example, prenatal care or well-baby visits.
    (iv) A program that reimburses employees for the costs of smoking 
cessation programs without regard to whether the employee quits smoking.
    (v) A program that provides a reward to employees for attending a 
monthly health education seminar.
    (2) Wellness programs subject to requirements. If any of the 
conditions for obtaining a reward under a wellness program is based on 
an individual satisfying a standard that is related to a health factor, 
the wellness program does not violate this section if the requirements 
of this paragraph (f)(2) are met.
    (i) The reward for the wellness program, coupled with the reward for 
other wellness programs with respect to the plan that require 
satisfaction of a standard related to a health factor, must not exceed 
20 percent of the cost of employee-only coverage under the plan. 
However, if, in addition to employees, any class of dependents (such as 
spouses or spouses and dependent children) may participate in the 
wellness program, the reward must not exceed 20 percent of the cost of 
the coverage in which an employee and any dependents are enrolled. For 
purposes of this paragraph (f)(2), the cost of coverage is determined 
based on the total amount of employer and employee contributions for the 
benefit package under which the employee is (or the employee and any 
dependents are) receiving coverage. A reward can be in the form of a 
discount or rebate of a premium or contribution, a waiver of all or part 
of a cost-sharing mechanism (such as deductibles, copayments, or 
coinsurance), the absence of a surcharge, or the value of a benefit that 
would otherwise not be provided under the plan.
    (ii) The program must be reasonably designed to promote health or 
prevent disease. A program satisfies this standard if it has a 
reasonable chance of improving the health of or preventing disease in 
participating individuals and it is not overly burdensome, is not a 
subterfuge for discriminating based on a health factor, and is not 
highly suspect in the method chosen to promote health or prevent 
disease.
    (iii) The program must give individuals eligible for the program the 
opportunity to qualify for the reward under the program at least once 
per year.

[[Page 444]]

    (iv) The reward under the program must be available to all similarly 
situated individuals.
    (A) A reward is not available to all similarly situated individuals 
for a period unless the program allows--
    (1) A reasonable alternative standard (or waiver of the otherwise 
applicable standard) for obtaining the reward for any individual for 
whom, for that period, it is unreasonably difficult due to a medical 
condition to satisfy the otherwise applicable standard; and
    (2) A reasonable alternative standard (or waiver of the otherwise 
applicable standard) for obtaining the reward for any individual for 
whom, for that period, it is medically inadvisable to attempt to satisfy 
the otherwise applicable standard.
    (B) A plan or issuer may seek verification, such as a statement from 
an individual's physician, that a health factor makes it unreasonably 
difficult or medically inadvisable for the individual to satisfy or 
attempt to satisfy the otherwise applicable standard.
    (v)(A) The plan must disclose in all plan materials describing the 
terms of the program the availability of a reasonable alternative 
standard (or the possibility of waiver of the otherwise applicable 
standard) required under paragraph (f)(2)(iv) of this section. However, 
if plan materials merely mention that a program is available, without 
describing its terms, this disclosure is not required.
    (B) The following language, or substantially similar language, can 
be used to satisfy the requirement of this paragraph (f)(2)(v): ``If it 
is unreasonably difficult due to a medical condition for you to achieve 
the standards for the reward under this program, or if it is medically 
inadvisable for you to attempt to achieve the standards for the reward 
under this program, call us at [insert telephone number] and we will 
work with you to develop another way to qualify for the reward.'' In 
addition, other examples of language that would satisfy this requirement 
are set forth in Examples 3, 4, and 5 of paragraph (f)(3) of this 
section.
    (3) Examples. The rules of paragraph (f)(2) of this section are 
illustrated by the following examples:

    Example 1. (i) Facts. An employer sponsors a group health plan. The 
annual premium for employee-only coverage is $3,600 (of which the 
employer pays $2,700 per year and the employee pays $900 per year). The 
annual premium for family coverage is $9,000 (of which the employer pays 
$4,500 per year and the employee pays $4,500 per year). The plan offers 
a wellness program with an annual premium rebate of $360. The program is 
available only to employees.
    (ii) Conclusion. In this Example 1, the program satisfies the 
requirements of paragraph (f)(2)(i) of this section because the reward 
for the wellness program, $360, does not exceed 20 percent of the total 
annual cost of employee-only coverage, $720. ($3,600 x 20% = $720.) If 
any class of dependents is allowed to participate in the program and the 
employee is enrolled in family coverage, the plan could offer the 
employee a reward of up to 20 percent of the cost of family coverage, 
$1,800. ($9,000 x 20% = $1,800.)
    Example 2. (i) Facts. A group health plan gives an annual premium 
discount of 20 percent of the cost of employee-only coverage to 
participants who adhere to a wellness program. The wellness program 
consists solely of giving an annual cholesterol test to participants. 
Those participants who achieve a count under 200 receive the premium 
discount for the year.
    (ii) Conclusion. In this Example 2, the program fails to satisfy the 
requirement of being available to all similarly situated individuals 
because some participants may be unable to achieve a cholesterol count 
of under 200 and the plan does not make available a reasonable 
alternative standard or waive the cholesterol standard. (In addition, 
plan materials describing the program are required to disclose the 
availability of a reasonable alternative standard (or the possibility of 
waiver of the otherwise applicable standard) for obtaining the premium 
discount. Thus, the premium discount violates paragraph (c) of this 
section because it may require an individual to pay a higher premium 
based on a health factor of the individual than is required of a 
similarly situated individual under the plan.
    Example 3. (i) Facts. Same facts as Example 2, except that the plan 
provides that if it is unreasonably difficult due to a medical condition 
for a participant to achieve the targeted cholesterol count (or if it is 
medically inadvisable for a participant to attempt to achieve the 
targeted cholesterol count) within a 60-day period, the plan will make 
available a reasonable alternative standard that takes the relevant 
medical condition into account. In addition, all plan materials 
describing the terms of the program include the following statement: 
``If it is unreasonably difficult due to a medical condition for you to 
achieve a cholesterol count under 200,

[[Page 445]]

or if it is medically inadvisable for you to attempt to achieve a count 
under 200, call us at the number below and we will work with you to 
develop another way to get the discount.'' Individual D begins a diet 
and exercise program but is unable to achieve a cholesterol count under 
200 within the prescribed period. D's doctor determines D requires 
prescription medication to achieve a medically advisable cholesterol 
count. In addition, the doctor determines that D must be monitored 
through periodic blood tests to continually reevaluate D's health 
status. The plan accommodates D by making the discount available to D, 
but only if D follows the advice of D's doctor's regarding medication 
and blood tests.
    (ii) Conclusion. In this Example 3, the program is a wellness 
program because it satisfies the five requirements of paragraph (f)(2) 
of this section. First, the program complies with the limits on rewards 
under a program. Second, it is reasonably designed to promote health or 
prevent disease. Third, individuals eligible for the program are given 
the opportunity to qualify for the reward at least once per year. 
Fourth, the reward under the program is available to all similarly 
situated individuals because it accommodates individuals for whom it is 
unreasonably difficult due to a medical condition to achieve the 
targeted count (or for whom it is medically inadvisable to attempt to 
achieve the targeted count) in the prescribed period by providing a 
reasonable alternative standard. Fifth, the plan discloses in all 
materials describing the terms of the program the availability of a 
reasonable alternative standard. Thus, the premium discount does not 
violate this section.
    Example 4. (i) Facts. A group health plan will waive the $250 annual 
deductible (which is less than 20 percent of the annual cost of 
employee-only coverage under the plan) for the following year for 
participants who have a body mass index between 19 and 26, determined 
shortly before the beginning of the year. However, any participant for 
whom it is unreasonably difficult due to a medical condition to attain 
this standard (and any participant for whom it is medically inadvisable 
to attempt to achieve this standard) during the plan year is given the 
same discount if the participant walks for 20 minutes three days a week. 
Any participant for whom it is unreasonably difficult due to a medical 
condition to attain either standard (and any participant for whom it is 
medically inadvisable to attempt to achieve either standard) during the 
year is given the same discount if the individual satisfies an 
alternative standard that is reasonable in the burden it imposes and is 
reasonable taking into consideration the individual's medical situation. 
All plan materials describing the terms of the wellness program include 
the following statement: ``If it is unreasonably difficult due to a 
medical condition for you to achieve a body mass index between 19 and 26 
(or if it is medically inadvisable for you to attempt to achieve this 
body mass index) this year, your deductible will be waived if you walk 
for 20 minutes three days a week. If you cannot follow the walking 
program, call us at the number above and we will work with you to 
develop another way to have your deductible waived.'' Due to a medical 
condition, Individual E is unable to achieve a BMI of between 19 and 26 
and is also unable to follow the walking program. E proposes a program 
based on the recommendations of E's physician. The plan agrees to make 
the discount available to E if E follows the physician's 
recommendations.
    (ii) Conclusion. In this Example 4, the program satisfies the five 
requirements of paragraph (f)(2) of this section. First, the program 
complies with the limits on rewards under a program. Second, it is 
reasonably designed to promote health or prevent disease. Third, 
individuals eligible for the program are given the opportunity to 
qualify for the reward at least once per year. Fourth, the reward under 
the program is available to all similarly situated individuals because 
it generally accommodates individuals for whom it is unreasonably 
difficult due to a medical condition to achieve (or for whom it is 
medically inadvisable to attempt to achieve) the targeted body mass 
index by providing a reasonable alternative standard (walking) and it 
accommodates individuals for whom it is unreasonably difficult due to a 
medical condition (or for whom it is medically inadvisable to attempt) 
to walk by providing an alternative standard that is reasonable for the 
individual. Fifth, the plan discloses in all materials describing the 
terms of the program the availability of a reasonable alternative 
standard for every individual. Thus, the waiver of the deductible does 
not violate this section.
    Example 5. (i) Facts. In conjunction with an annual open enrollment 
period, a group health plan provides a form for participants to certify 
that they have not used tobacco products in the preceding twelve months. 
Participants who do not provide the certification are assessed a 
surcharge that is 20 percent of the cost of employee-only coverage. 
However, all plan materials describing the terms of the wellness program 
include the following statement: ``If it is unreasonably difficult due 
to a health factor for you to meet the requirements under this program 
(or if it is medically inadvisable for you to attempt to meet the 
requirements of this program), we will make available a reasonable 
alternative standard for you to avoid this surcharge.'' It is 
unreasonably difficult for Individual F to stop smoking cigarettes due 
to an addiction to nicotine (a medical

[[Page 446]]

condition). The plan accommodates F by requiring F to participate in a 
smoking cessation program to avoid the surcharge. F can avoid the 
surcharge for as long as F participates in the program, regardless of 
whether F stops smoking (as long as F continues to be addicted to 
nicotine).
    (ii) Conclusion. In this Example 5, the premium surcharge is 
permissible as a wellness program because it satisfies the five 
requirements of paragraph (f)(2) of this section. First, the program 
complies with the limits on rewards under a program. Second, it is 
reasonably designed to promote health or prevent disease. Third, 
individuals eligible for the program are given the opportunity to 
qualify for the reward at least once per year. Fourth, the reward under 
the program is available to all similarly situated individuals because 
it accommodates individuals for whom it is unreasonably difficult due to 
a medical condition (or for whom it is medically inadvisable to attempt) 
to quit using tobacco products by providing a reasonable alternative 
standard. Fifth, the plan discloses in all materials describing the 
terms of the program the availability of a reasonable alternative 
standard. Thus, the premium surcharge does not violate this section.
    Example 6. (i) Facts. Same facts as Example 5, except the plan 
accommodates F by requiring F to view, over a period of 12 months, a 12-
hour video series on health problems associated with tobacco use. F can 
avoid the surcharge by complying with this requirement.
    (ii) Conclusion. In this Example 6, the requirement to watch the 
series of video tapes is a reasonable alternative method for avoiding 
the surcharge.

    (g) More favorable treatment of individuals with adverse health 
factors permitted--(1) In rules for eligibility. (i) Nothing in this 
section prevents a group health plan from establishing more favorable 
rules for eligibility (described in paragraph (b)(1) of this section) 
for individuals with an adverse health factor, such as disability, than 
for individuals without the adverse health factor. Moreover, nothing in 
this section prevents a plan from charging a higher premium or 
contribution with respect to individuals with an adverse health factor 
if they would not be eligible for the coverage were it not for the 
adverse health factor. (However, other laws, including State insurance 
laws, may set or limit premium rates; these laws are not affected by 
this section.)
    (ii) The rules of this paragraph (g)(1) are illustrated by the 
following examples:

    Example 1. (i) Facts. An employer sponsors a group health plan that 
generally is available to employees, spouses of employees, and dependent 
children until age 23. However, dependent children who are disabled are 
eligible for coverage beyond age 23.
    (ii) Conclusion. In this Example 1, the plan provision allowing 
coverage for disabled dependent children beyond age 23 satisfies this 
paragraph (g)(1) (and thus does not violate this section).
    Example 2. (i) Facts. An employer sponsors a group health plan, 
which is generally available to employees (and members of the employee's 
family) until the last day of the month in which the employee ceases to 
perform services for the employer. The plan generally charges employees 
$50 per month for employee-only coverage and $125 per month for family 
coverage. However, an employee who ceases to perform services for the 
employer by reason of disability may remain covered under the plan until 
the last day of the month that is 12 months after the month in which the 
employee ceased to perform services for the employer. During this 
extended period of coverage, the plan charges the employee $100 per 
month for employee-only coverage and $250 per month for family coverage. 
(This extended period of coverage is without regard to whatever rights 
the employee (or members of the employee's family) may have for COBRA 
continuation coverage.)
    (ii) Conclusion. In this Example 2, the plan provision allowing 
extended coverage for disabled employees and their families satisfies 
this paragraph (g)(1) (and thus does not violate this section). In 
addition, the plan is permitted, under this paragraph (g)(1), to charge 
the disabled employees a higher premium during the extended period of 
coverage.
    Example 3. (i) Facts. To comply with the requirements of a COBRA 
continuation provision, a group health plan generally makes COBRA 
continuation coverage available for a maximum period of 18 months in 
connection with a termination of employment but makes the coverage 
available for a maximum period of 29 months to certain disabled 
individuals and certain members of the disabled individual's family. 
Although the plan generally requires payment of 102 percent of the 
applicable premium for the first 18 months of COBRA continuation 
coverage, the plan requires payment of 150 percent of the applicable 
premium for the disabled individual's COBRA continuation coverage during 
the disability extension if the disabled individual would not be 
entitled to COBRA continuation coverage but for the disability.

[[Page 447]]

    (ii) Conclusion. In this Example 3, the plan provision allowing 
extended COBRA continuation coverage for disabled individuals satisfies 
this paragraph (g)(1) (and thus does not violate this section). In 
addition, the plan is permitted, under this paragraph (g)(1), to charge 
the disabled individuals a higher premium for the extended coverage if 
the individuals would not be eligible for COBRA continuation coverage 
were it not for the disability. (Similarly, if the plan provided an 
extended period of coverage for disabled individuals pursuant to State 
law or plan provision rather than pursuant to a COBRA continuation 
coverage provision, the plan could likewise charge the disabled 
individuals a higher premium for the extended coverage.)

    (2) In premiums or contributions--(i) Nothing in this section 
prevents a group health plan from charging individuals a premium or 
contribution that is less than the premium (or contribution) for 
similarly situated individuals if the lower charge is based on an 
adverse health factor, such as disability.
    (ii) The rules of this paragraph (g)(2) are illustrated by the 
following example:

    Example. (i) Facts. Under a group health plan, employees are 
generally required to pay $50 per month for employee-only coverage and 
$125 per month for family coverage under the plan. However, employees 
who are disabled receive coverage (whether employee-only or family 
coverage) under the plan free of charge.
    (ii) Conclusion. In this Example, the plan provision waiving premium 
payment for disabled employees is permitted under this paragraph (g)(2) 
(and thus does not violate this section).

    (h) No effect on other laws. Compliance with this section is not 
determinative of compliance with any provision of ERISA (including the 
COBRA continuation provisions) or any other State or Federal law, such 
as the Americans with Disabilities Act. Therefore, although the rules of 
this section would not prohibit a plan from treating one group of 
similarly situated individuals differently from another (such as 
providing different benefit packages to current and former employees), 
other Federal or State laws may require that two separate groups of 
similarly situated individuals be treated the same for certain purposes 
(such as making the same benefit package available to COBRA qualified 
beneficiaries as is made available to active employees). In addition, 
although this section generally does not impose new disclosure 
obligations on plans, this section does not affect any other laws, 
including those that require accurate disclosures and prohibit 
intentional misrepresentation.
    (i) Applicability dates. This section applies for plan years 
beginning on or after July 1, 2007.

[T.D. 9298, 71 FR 75030, Dec. 13, 2006; 72 FR 7929, Feb. 22, 2007, as 
amended by T.D. 9464, 74 FR 51678, Oct. 7, 2009]



Sec. 54.9802-2  Special rules for certain church plans.

    (a) Exception for certain church plans--(1) Church plans in general. 
A church plan described in paragraph (b) of this section is not treated 
as failing to meet the requirements of section 9802 or Sec. 54.9802-1 
solely because the plan requires evidence of good health for coverage of 
individuals under plan provisions described in paragraph (b)(2) or (3) 
of this section.
    (2) Health insurance issuers. See sections 2702 and 2721(b)(1)(B) of 
the Public Health Service Act (42 U.S.C. 300gg-2 and 300gg-21(b)(1)(B)) 
and 45 CFR 146.121, which require health insurance issuers providing 
health insurance coverage under a church plan that is a group health 
plan to comply with nondiscrimination requirements similar to those that 
church plans are required to comply with under section 9802 and Sec. 
54.9802-1 except that those nondiscrimination requirements do not 
include an exception for health insurance issuers comparable to the 
exception for church plans under section 9802(c) and this section.
    (b) Church plans to which this section applies--(1) Church plans 
with certain coverage provisions in effect on July 15, 1997. This 
section applies to any church plan (as defined in section 414(e)) for a 
plan year if, on July 15, 1997 and at all times thereafter before the 
beginning of the plan year, the plan contains either the provisions 
described in paragraph (b)(2) of this section or the provisions 
described in paragraph (b)(3) of this section.
    (2) Plan provisions applicable to individuals employed by employers 
of 10 or

[[Page 448]]

fewer employees and self-employed individuals. (i) A plan contains the 
provisions described in this paragraph (b)(2) if it requires evidence of 
good health of both--
    (A) Any employee of an employer of 10 or fewer employees (determined 
without regard to section 414(e)(3)(C), under which a church or 
convention or association of churches is treated as the employer); and
    (B) Any self-employed individual.
    (ii) A plan does not contain the provisions described in this 
paragraph (b)(2) if the plan contains only one of the provisions 
described in this paragraph (b)(2). Thus, for example, a plan that 
requires evidence of good health of any self-employed individual, but 
not of any employee of an employer with 10 or fewer employees, does not 
contain the provisions described in this paragraph (b)(2). Moreover, a 
plan does not contain the provision described in paragraph (b)(2)(i)(A) 
of this section if the plan requires evidence of good health of any 
employee of an employer of fewer than 10 (or greater than 10) employees. 
Thus, for example, a plan does not contain the provision described in 
paragraph (b)(2)(i)(A) of this section if the plan requires evidence of 
good health of any employee of an employer with five or fewer employees.
    (3) Plan provisions applicable to individuals who enroll after the 
first 90 days of initial eligibility. (i) A plan contains the provisions 
described in this paragraph (b)(3) if it requires evidence of good 
health of any individual who enrolls after the first 90 days of initial 
eligibility under the plan.
    (ii) A plan does not contain the provisions described in this 
paragraph (b)(3) if it provides for a longer (or shorter) period than 90 
days. Thus, for example, a plan requiring evidence of good health of any 
individual who enrolls after the first 120 days of initial eligibility 
under the plan does not contain the provisions described in this 
paragraph (b)(3).
    (c) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1. (i) Facts. A church organization maintains two church 
plans for entities affiliated with the church. One plan is a group 
health plan that provides health coverage to all employees (including 
ministers and lay workers) of any affiliated church entity that has more 
than 10 employees. The other plan is Plan O, which is a group health 
plan that is not funded through insurance coverage and that provides 
health coverage to any employee (including ministers and lay workers) of 
any affiliated church entity that has 10 or fewer employees and any 
self-employed individual affiliated with the church (including a self-
employed minister of the church). Plan O requires evidence of good 
health in order for any individual of a church entity that has 10 or 
fewer employees to be covered and in order for any self-employed 
individual to be covered. On July 15, 1997 and at all times thereafter 
before the beginning of the plan year, Plan O has contained all the 
preceding provisions.
    (ii) Conclusion. In this Example 1, because Plan O contains the plan 
provisions described in paragraph (b)(2) of this section and because 
those provisions were in the plan on July 15, 1997 and at all times 
thereafter before the beginning of the plan year, Plan O will not be 
treated as failing to meet the requirements of section 9802 or Sec. 
54.9802-1 for the plan year solely because the plan requires evidence of 
good health for coverage of the individuals described in those plan 
provisions.
    Example 2. (i) Facts. A church organization maintains Plan P, which 
is a church plan that is not funded through insurance coverage and that 
is a group health plan providing health coverage to individuals employed 
by entities affiliated with the church and self-employed individuals 
affiliated with the church (such as ministers). On July 15, 1997 and at 
all times thereafter before the beginning of the plan year, Plan P has 
required evidence of good health for coverage of any individual who 
enrolls after the first 90 days of initial eligibility under the plan.
    (ii) Conclusion. In this Example 2, because Plan P contains the plan 
provisions described in paragraph (b)(3) of this section and because 
those provisions were in the plan on July 15, 1997 and at all times 
thereafter before the beginning of the plan year, Plan P will not be 
treated as failing to meet the requirements of section 9802 or Sec. 
54.9802-1 for the plan year solely because the plan requires evidence of 
good health for coverage of individuals enrolling after the first 90 
days of initial eligibility under the plan.

    (d) Applicability date. This section is applicable to plan years 
beginning on or after July 1, 2007.

[T.D. 9299, 71 FR 75056, Dec. 13, 2006]

[[Page 449]]



Sec. 54.9802-3T  Additional requirements prohibiting discrimination
based on genetic information (temporary).

    (a) Definitions. Unless otherwise provided, the definitions in this 
paragraph (a) govern in applying the provisions of this section.
    (1) Collect means, with respect to information, to request, require, 
or purchase such information.
    (2) Family member means, with respect to an individual --
    (i) A dependent (as defined for purposes of Sec. 54.9801-2) of the 
individual; or
    (ii) Any other person who is a first-degree, second-degree, third-
degree, or fourth-degree relative of the individual or of a dependent of 
the individual. Relatives by affinity (such as by marriage or adoption) 
are treated the same as relatives by consanguinity (that is, relatives 
who share a common biological ancestor). In determining the degree of 
the relationship, relatives by less than full consanguinity (such as 
half-siblings, who share only one parent) are treated the same as 
relatives by full consanguinity (such as siblings who share both 
parents).
    (A) First-degree relatives include parents, spouses, siblings, and 
children.
    (B) Second-degree relatives include grandparents, grandchildren, 
aunts, uncles, nephews, and nieces.
    (C) Third-degree relatives include great-grandparents, great-
grandchildren, great aunts, great uncles, and first cousins.
    (D) Fourth-degree relatives include great-great grandparents, great-
great grandchildren, and children of first cousins.
    (3) Genetic information means--
    (i) Subject to paragraphs (a)(3)(ii) and (a)(3)(iii) of this 
section, with respect to an individual, information about--
    (A) The individual's genetic tests (as defined in paragraph (a)(5) 
of this section);
    (B) The genetic tests of family members of the individual;
    (C) The manifestation (as defined in paragraph (a)(6) of this 
section) of a disease or disorder in family members of the individual; 
or
    (D) Any request for, or receipt of, genetic services (as defined in 
paragraph (a)(4) of this section), or participation in clinical research 
which includes genetic services, by the individual or any family member 
of the individual.
    (ii) The term genetic information does not include information about 
the sex or age of any individual.
    (iii) The term genetic information includes--
    (A) With respect to a pregnant woman (or a family member of the 
pregnant woman), genetic information of any fetus carried by the 
pregnant woman; and
    (B) With respect to an individual (or a family member of the 
individual) who is utilizing an assisted reproductive technology, 
genetic information of any embryo legally held by the individual or 
family member.
    (4) Genetic services means--
    (i) A genetic test, as defined in paragraph (a)(5) of this section;
    (ii) Genetic counseling (including obtaining, interpreting, or 
assessing genetic information); or
    (iii) Genetic education.
    (5)(i) Genetic test means an analysis of human DNA, RNA, 
chromosomes, proteins, or metabolites, if the analysis detects 
genotypes, mutations, or chromosomal changes. However, a genetic test 
does not include an analysis of proteins or metabolites that is directly 
related to a manifested disease, disorder, or pathological condition. 
Accordingly, a test to determine whether an individual has a BRCA1 or 
BRCA2 variant is a genetic test. Similarly, a test to determine whether 
an individual has a genetic variant associated with hereditary 
nonpolyposis colorectal cancer is a genetic test. However, an HIV test, 
complete blood count, cholesterol test, liver function test, or test for 
the presence of alcohol or drugs is not a genetic test.
    (ii) The rules of this paragraph (a)(5) are illustrated by the 
following example:

    Example. (i) Facts. Individual A is a newborn covered under a group 
health plan. A undergoes a phenylketonuria (PKU) screening, which 
measures the concentration of a metabolite, phenylalanine, in A's blood. 
In PKU, a mutation occurs in the phenylalanine hydroxylase (PAH) gene 
which contains instructions for making the enzyme needed to break down 
the amino acid phenylalanine. Individuals with the mutation, who have a 
deficiency in the enzyme to

[[Page 450]]

break down phenylalanine, have high concentrations of phenylalanine.
    (ii) Conclusion. In this Example, the PKU screening is a genetic 
test with respect to A because the screening is an analysis of 
metabolites that detects a genetic mutation.
    (6)(i) Manifestation or manifested means, with respect to a disease, 
disorder, or pathological condition, that an individual has been or 
could reasonably be diagnosed with the disease, disorder, or 
pathological condition by a health care professional with appropriate 
training and expertise in the field of medicine involved. For purposes 
of this section, a disease, disorder, or pathological condition is not 
manifested if a diagnosis is based principally on genetic information.
    (ii) The rules of this paragraph (a)(6) are illustrated by the 
following examples:

    Example 1. (i) Facts. Individual A has a family medical history of 
diabetes. A begins to experience excessive sweating, thirst, and 
fatigue. A's physician examines A and orders blood glucose testing 
(which is not a genetic test). Based on the physician's examination, A's 
symptoms, and test results that show elevated levels of blood glucose, 
A's physician diagnoses A as having adult onset diabetes mellitus (Type 
2 diabetes).
    (ii) Conclusion. In this Example 1, A has been diagnosed by a health 
care professional with appropriate training and expertise in the field 
of medicine involved. The diagnosis is not based principally on genetic 
information. Thus, Type 2 diabetes is manifested with respect to A.
    Example 2. (i) Facts. Individual B has several family members with 
colon cancer. One of them underwent genetic testing which detected a 
mutation in the MSH2 gene associated with hereditary nonpolyposis 
colorectal cancer (HNPCC). B's physician, a health care professional 
with appropriate training and expertise in the field of medicine 
involved, recommends that B undergo a targeted genetic test to look for 
the specific mutation found in B's relative to determine if B has an 
elevated risk for cancer. The genetic test with respect to B showed that 
B also carries the mutation and is at increased risk to develop 
colorectal and other cancers associated with HNPCC. B has a colonoscopy 
which indicates no signs of disease, and B has no symptoms.
    (ii) Conclusion. In this Example 2, because B has no signs or 
symptoms of colorectal cancer, B has not been and could not reasonably 
be diagnosed with HNPCC. Thus, HNPCC is not manifested with respect to 
B.
    Example 3. (i) Facts. Same facts as Example 2, except that B's 
colonoscopy and subsequent tests indicate the presence of HNPCC. Based 
on the colonoscopy and subsequent test results, B's physician makes a 
diagnosis of HNPCC.
    (ii) Conclusion. In this Example 3, HNPCC is manifested with respect 
to B because a health care professional with appropriate training and 
expertise in the field of medicine involved has made a diagnosis that is 
not based principally on genetic information.
    Example 4. (i) Facts. Individual C has a family member that has been 
diagnosed with Huntington's Disease. A genetic test indicates that C has 
the Huntington's Disease gene variant. At age 42, C begins suffering 
from occasional moodiness and disorientation, symptoms which are 
associated with Huntington's Disease. C is examined by a neurologist (a 
physician with appropriate training and expertise for diagnosing 
Huntington's Disease). The examination includes a clinical neurological 
exam. The results of the examination do not support a diagnosis of 
Huntington's Disease.
    (ii) Conclusion. In this Example 4, C is not and could not 
reasonably be diagnosed with Huntington's Disease by a health care 
professional with appropriate training and expertise. Therefore, 
Huntington's Disease is not manifested with respect to C.
    Example 5. (i) Facts. Same facts as Example 4, except that C 
exhibits additional neurological and behavioral symptoms, and the 
results of the examination support a diagnosis of Huntington's Disease 
with respect to C.
    (ii) Conclusion. In this Example 5, C could reasonably be diagnosed 
with Huntington's Disease by a health care professional with appropriate 
training and expertise. Therefore, Huntington's Disease is manifested 
with respect to C.

    (7) Underwriting purposes has the meaning given in paragraph (d)(1) 
of this section.
    (b) No group-based discrimination based on genetic information--(1) 
In general. For purposes of this section, a group health plan must not 
adjust premium or contribution amounts for any employer, or any group of 
similarly situated individuals under the plan, on the basis of genetic 
information. For this purpose, ``similarly situated individuals'' are 
those described in Sec. 54.9802-1(d).
    (2) Rule of construction. Nothing in paragraph (b)(1) of this 
section (or in paragraph (d)(1) or (d)(2) of this section) limits the 
ability of a group health plan to increase the premium for an employer 
or for a group of similarly situated individuals under the plan based on 
the manifestation of a

[[Page 451]]

disease or disorder of an individual who is enrolled in the plan. In 
such a case, however, the manifestation of a disease or disorder in one 
individual cannot also be used as genetic information about other group 
members to further increase the premium for an employer or a group of 
similarly situated individuals under the plan.
    (3) Examples. The rules of this paragraph (b) are illustrated by the 
following examples:

    Example 1. (i) Facts. An employer sponsors a group health plan that 
provides coverage through a health insurance issuer. In order to 
determine the premium rate for the upcoming plan year, the issuer 
reviews the claims experience of individuals covered under the plan and 
other health status information of the individuals, including genetic 
information. The issuer finds that three individuals covered under the 
plan had unusually high claims experience. In addition, the issuer finds 
that the genetic information of two other individuals indicates the 
individuals have a higher probability of developing certain illnesses 
although the illnesses are not manifested at this time. The issuer 
quotes the plan a higher per-participant rate because of both the 
genetic information and the higher claims experience.
    (ii) Conclusion. See Example 1 in 29 CFR 2590.702-1(b)(3) or 45 CFR 
146.122(b)(3) for a conclusion that the issuer violates the provisions 
of 29 CFR 2590.702-1(b) or 45 CFR 146.122(b) similar to the requirements 
of this paragraph (b) because the issuer adjusts the premium based on 
genetic information. However, if the adjustment related solely to claims 
experience, the adjustment would not violate the requirements of 29 CFR 
2590.702-1 or 45 CFR 146.122 similar to the requirements of this section 
(nor would it violate the requirements of paragraph (c) of 29 CFR 
2590.702 or 45 CFR 146.121 similar to the requirements of paragraph (c) 
of Sec. 54.9802-1, which prohibits discrimination in individual 
premiums or contributions based on a health factor but permits increases 
in the group rate based on a health factor).
    Example 2. (i) Facts. An employer sponsors a group health plan that 
provides coverage through a health insurance issuer. In order to 
determine the premium rate for the upcoming plan year, the issuer 
reviews the claims experience of individuals covered under the plan and 
other health status information of the individuals, including genetic 
information. The issuer finds that Employee A has made claims for 
treatment of polycystic kidney disease. A also has two dependent 
children covered under the plan. The issuer quotes the plan a higher 
per-participant rate because of both A's claims experience and the 
family medical history of A's children (that is, the fact that A has the 
disease).
    (ii) Conclusion. See Example 2 in 29 CFR 2590.702-1(b)(3) or 45 CFR 
146.122(b)(3) for a conclusion that the issuer violates the provisions 
of 29 CFR 2590.702-1(b) or 45 CFR 146.122(b) similar to the requirements 
of this paragraph (b) because, by taking the likelihood that A's 
children may develop polycystic kidney disease into account in computing 
the rate for the plan, the issuer adjusts the premium based on genetic 
information relating to a condition that has not been manifested in A's 
children. However, the issuer does not violate the requirements of 29 
CFR 2590.702-1(b) or 45 CFR 146.122(b) similar to the requirements of 
this paragraph (b) by increasing the premium based on A's claims 
experience.

    (c) Limitation on requesting or requiring genetic testing--(1) 
General rule. Except as otherwise provided in this paragraph (c), a 
group health plan must not request or require an individual or a family 
member of the individual to undergo a genetic test.
    (2) Health care professional may recommend a genetic test. Nothing 
in paragraph (c)(1) of this section limits the authority of a health 
care professional who is providing health care services to an individual 
to request that the individual undergo a genetic test.
    (3) Examples. The rules of paragraphs (c)(1) and (c)(2) of this 
section are illustrated by the following examples:

    Example 1. (i) Facts. Individual A goes to a physician for a routine 
physical examination. The physician reviews A's family medical history 
and A informs the physician that A's mother has been diagnosed with 
Huntington's Disease. The physician advises A that Huntington's Disease 
is hereditary and recommends that A undergo a genetic test.
    (ii) Conclusion. In this Example 1, the physician is a health care 
professional who is providing health care services to A. Therefore, the 
physician's recommendation that A undergo the genetic test does not 
violate this paragraph (c).
    Example 2. (i) Facts. Individual B is covered by a health 
maintenance organization (HMO). B is a child being treated for leukemia. 
B's physician, who is employed by the HMO, is considering a treatment 
plan that includes six-mercaptopurine, a drug for treating leukemia in 
most children. However, the drug could be fatal if taken by a small 
percentage of children with a particular gene variant. B's physician 
recommends that B undergo a genetic test to detect this variant before 
proceeding with this course of treatment.

[[Page 452]]

    (ii) Conclusion. In this Example 2, even though the physician is 
employed by the HMO, the physician is nonetheless a health care 
professional who is providing health care services to B. Therefore, the 
physician's recommendation that B undergo the genetic test does not 
violate this paragraph (c).

    (4) Determination regarding payment--(i) In general. As provided in 
this paragraph (c)(4), nothing in paragraph (c)(1) of this section 
precludes a plan from obtaining and using the results of a genetic test 
in making a determination regarding payment. For this purpose, 
``payment'' has the meaning given such term in 45 CFR 164.501 of the 
privacy regulations issued under the Health Insurance Portability and 
Accountability Act. Thus, if a plan conditions payment for an item or 
service based on its medical appropriateness and the medical 
appropriateness of the item or service depends on the genetic makeup of 
a patient, then the plan is permitted to condition payment for the item 
or service on the outcome of a genetic test. The plan may also refuse 
payment if the patient does not undergo the genetic test.
    (ii) Limitation. A plan is permitted to request only the minimum 
amount of information necessary to make a determination regarding 
payment. The minimum amount of information necessary is determined in 
accordance with the minimum necessary standard in 45 CFR 164.502(b) of 
the privacy regulations issued under the Health Insurance Portability 
and Accountability Act.
    (iii) Examples. See paragraph (e) of this section for examples 
illustrating the rules of this paragraph (c)(4), as well as other 
provisions of this section.
    (5) Research exception. Notwithstanding paragraph (c)(1) of this 
section, a plan may request, but not require, that a participant or 
beneficiary undergo a genetic test if all of the conditions of this 
paragraph (c)(5) are met:
    (i) Research in accordance with Federal regulations and applicable 
State or local law or regulations. The plan makes the request pursuant 
to research, as defined in 45 CFR 46.102(d), that complies with 45 CFR 
Part 46 or equivalent Federal regulations, and any applicable State or 
local law or regulations for the protection of human subjects in 
research.
    (ii) Written request for participation in research. The plan makes 
the request in writing, and the request clearly indicates to each 
participant or beneficiary (or, in the case of a minor child, to the 
legal guardian of the beneficiary) that--
    (A) Compliance with the request is voluntary; and
    (B) Noncompliance will have no effect on eligibility for benefits 
(as described in Sec. 54.9802-1(b)(1)) or premium or contribution 
amounts.
    (iii) Prohibition on underwriting. No genetic information collected 
or acquired under this paragraph (c)(5) can be used for underwriting 
purposes (as described in paragraph (d)(1) of this section).
    (iv) Notice to Federal agencies. The plan completes a copy of the 
``Notice of Research Exception under the Genetic Information 
Nondiscrimination Act'' authorized by the Secretary and provides the 
notice to the address specified in the instructions thereto.
    (d) Prohibitions on collection of genetic information--(1) For 
underwriting purposes--(i) General rule. A group health plan must not 
collect (as defined in paragraph (a)(1) of this section) genetic 
information for underwriting purposes. See paragraph (e) of this section 
for examples illustrating the rules of this paragraph (d)(1), as well as 
other provisions of this section.
    (ii) Underwriting purposes defined. Subject to paragraph (d)(1)(iii) 
of this section, underwriting purposes means, with respect to any group 
health plan, or health insurance coverage offered in connection with a 
group health plan--
    (A) Rules for, or determination of, eligibility (including 
enrollment and continued eligibility) for benefits under the plan or 
coverage as described in Sec. 54.9802-1(b)(1)(ii) (including changes in 
deductibles or other cost-sharing mechanisms in return for activities 
such as completing a health risk assessment or participating in a 
wellness program);
    (B) The computation of premium or contribution amounts under the 
plan or coverage (including discounts, rebates, payments in kind, or 
other premium differential mechanisms in return for activities such as 
completing a

[[Page 453]]

health risk assessment or participating in a wellness program);
    (C) The application of any preexisting condition exclusion under the 
plan or coverage; and
    (D) Other activities related to the creation, renewal, or 
replacement of a contract of health insurance or health benefits.
    (iii) Medical appropriateness. If an individual seeks a benefit 
under a group health plan, the plan may limit or exclude the benefit 
based on whether the benefit is medically appropriate, and the 
determination of whether the benefit is medically appropriate is not 
within the meaning of underwriting purposes. Accordingly, if an 
individual seeks a benefit under the plan and the plan conditions the 
benefit based on its medical appropriateness and the medical 
appropriateness of the benefit depends on genetic information of the 
individual, then the plan is permitted to condition the benefit on the 
genetic information. A plan is permitted to request only the minimum 
amount of genetic information necessary to determine medical 
appropriateness. The plan may deny the benefit if the patient does not 
provide the genetic information required to determine medical 
appropriateness. If an individual is not seeking a benefit, the medical 
appropriateness exception of this paragraph (d)(1)(iii) to the 
definition of underwriting purposes does not apply. See paragraph (e) of 
this section for examples illustrating the medical appropriateness 
provisions of this paragraph (d)(1)(iii), as well as other provisions of 
this section.
    (2) Prior to or in connection with enrollment--(i) In general. A 
group health plan must not collect genetic information with respect to 
any individual prior to that individual's effective date of coverage 
under that plan, nor in connection with the rules for eligibility (as 
defined in Sec. 54.9802-1(b)(1)(ii)) that apply to that individual. 
Whether or not an individual's information is collected prior to that 
individual's effective date of coverage is determined at the time of 
collection.
    (ii) Incidental collection exception--(A) In general. If a group 
health plan obtains genetic information incidental to the collection of 
other information concerning any individual, the collection is not a 
violation of this paragraph (d)(2), as long as the collection is not for 
underwriting purposes in violation of paragraph (d)(1) of this section.

    (B) Limitation. The incidental collection exception of this 
paragraph (d)(2)(ii) does not apply in connection with any collection 
where it is reasonable to anticipate that health information will be 
received, unless the collection explicitly states that genetic 
information should not be provided.
    (3) Examples. The rules of this paragraph (d) are illustrated by the 
following examples:

    Example 1. (i) Facts. A group health plan provides a premium 
reduction to enrollees who complete a health risk assessment. The health 
risk assessment is requested to be completed after enrollment. Whether 
or not it is completed or what responses are given on it has no effect 
on an individual's enrollment status, or on the enrollment status of 
members of the individual's family. The health risk assessment includes 
questions about the individual's family medical history.
    (ii) Conclusion. In this Example 1, the health risk assessment 
includes a request for genetic information (that is, the individual's 
family medical history). Because completing the health risk assessment 
results in a premium reduction, the request for genetic information is 
for underwriting purposes. Consequently, the request violates the 
prohibition on the collection of genetic information in paragraph (d)(1) 
of this section.
    Example 2. (i) Facts. The same facts as Example 1, except there is 
no premium reduction or any other reward for completing the health risk 
assessment.
    (ii) Conclusion. In this Example 2, the request is not for 
underwriting purposes, nor is it prior to or in connection with 
enrollment. Therefore, it does not violate the prohibition on the 
collection of genetic information in this paragraph (d).
    Example 3. (i) Facts. A group health plan requests that enrollees 
complete a health risk assessment prior to enrollment, and includes 
questions about the individual's family medical history. There is no 
reward or penalty for completing the health risk assessment.
    (ii) Conclusion. In this Example 3, because the health risk 
assessment includes a request for genetic information (that is, the 
individual's family medical history), and requests the information prior 
to enrollment, the request violates the prohibition on the collection of 
genetic information in paragraph (d)(2) of this section. Moreover, 
because it is a request for genetic information,

[[Page 454]]

it is not an incidental collection under paragraph (d)(2)(ii) of this 
section.
    Example 4. (i) Facts. The facts are the same as in Example 1, except 
there is no premium reduction or any other reward given for completion 
of the health risk assessment. However, certain people completing the 
health risk assessment may become eligible for additional benefits under 
the plan by being enrolled in a disease management program based on 
their answers to questions about family medical history. Other people 
may become eligible for the disease management program based solely on 
their answers to questions about their individual medical history.
    (ii) Conclusion. In this Example 4, the request for information 
about an individual's family medical history could result in the 
individual being eligible for benefits for which the individual would 
not otherwise be eligible. Therefore, the questions about family medical 
history on the health risk assessment are a request for genetic 
information for underwriting purposes and are prohibited under this 
paragraph (d). Although the plan conditions eligibility for the disease 
management program based on determinations of medical appropriateness, 
the exception for determinations of medical appropriateness does not 
apply because the individual is not seeking benefits.
    Example 5. (i) Facts. A group health plan requests enrollees to 
complete two distinct health risk assessments (HRAs) after and unrelated 
to enrollment. The first HRA instructs the individual to answer only for 
the individual and not for the individual's family. The first HRA does 
not ask about any genetic tests the individual has undergone or any 
genetic services the individual has received. The plan offers a reward 
for completing the first HRA. The second HRA asks about family medical 
history and the results of genetic tests the individual has undergone. 
The plan offers no reward for completing the second HRA and the 
instructions make clear that completion of the second HRA is wholly 
voluntary and will not affect the reward given for completion of the 
first HRA.
    (ii) Conclusion. In this Example 5, no genetic information is 
collected in connection with the first HRA, which offers a reward, and 
no benefits or other rewards are conditioned on the request for genetic 
information in the second HRA. Consequently, the request for genetic 
information in the second HRA is not for underwriting purposes, and the 
two HRAs do not violate the prohibition on the collection of genetic 
information in this paragraph (d).
    Example 6. (i) Facts. A group health plan waives its annual 
deductible for enrollees who complete an HRA. The HRA is requested to be 
completed after enrollment. Whether or not the HRA is completed or what 
responses are given on it has no effect on an individual's enrollment 
status, or on the enrollment status of members of the individual's 
family. The HRA does not include any direct questions about the 
individual's genetic information (including family medical history). 
However, the last question reads, ``Is there anything else relevant to 
your health that you would like us to know or discuss with you?''
    (ii) Conclusion. In this Example 6, the plan's request for medical 
information does not explicitly state that genetic information should 
not be provided. Therefore, any genetic information collected in 
response to the question is not within the incidental collection 
exception and is prohibited under this paragraph (d).
    Example 7. (i) Facts. Same facts as Example 6, except that the last 
question goes on to state, ``In answering this question, you should not 
include any genetic information. That is, please do not include any 
family medical history or any information related to genetic testing, 
genetic services, genetic counseling, or genetic diseases for which you 
believe you may be at risk.''
    (ii) Conclusion. In this Example 7, the plan's request for medical 
information explicitly states that genetic information should not be 
provided. Therefore, any genetic information collected in response to 
the question is within the incidental collection exception. However, the 
plan may not use any genetic information it obtains incidentally for 
underwriting purposes.
    Example 8. (i) Facts. Issuer M acquires Issuer N. M requests N's 
records, stating that N should not provide genetic information and 
should review the records to excise any genetic information. N assembles 
the data requested by M and, although N reviews it to delete genetic 
information, the data from a specific region included some individuals' 
family medical history. Consequently, M receives genetic information 
about some of N's covered individuals.
    (ii) Conclusion. In this Example 8, M's request for health 
information explicitly stated that genetic information should not be 
provided. See Example 8 in 29 CFR 2590.702-1(d)(3) or 45 CFR 
146.122(d)(3) for a conclusion that the collection of genetic 
information was within the incidental collection exception of 29 CFR 
2590.702-1(d)(2)(ii) or 45 CFR 146.122(d)(ii) similar to the incidental 
exception of paragraph (d)(2)(ii) of this section. See Example 8 in 29 
CFR 2590.702-1(d)(3) or 45 CFR 146.122(d)(3) also for a caveat that M 
may not use the genetic information it obtained incidentally for 
underwriting purposes.

    (e) Examples regarding determinations of medical appropriateness. 
The application of the rules of paragraphs (c) and

[[Page 455]]

(d) of this section to plan determinations of medical appropriateness is 
illustrated by the following examples:

    Example 1. (i) Facts. Individual A's group health plan covers 
genetic testing for celiac disease for individuals who have family 
members with this condition. After A's son is diagnosed with celiac 
disease, A undergoes a genetic test and promptly submits a claim for the 
test to A's issuer for reimbursement. The issuer asks A to provide the 
results of the genetic test before the claim is paid.
    (ii) Conclusion. See Example 1 in 29 CFR 2590.702-1(e) or 45 CFR 
146.122(e) for a conclusion under the rules of paragraph (c)(4) of 29 
CFR 2590.702-1 or 45 CFR 146.122 similar to the rules of paragraph 
(c)(4) of this section that the issuer is permitted to request only the 
minimum amount of information necessary to make a decision regarding 
payment. Because the results of the test are not necessary for the 
issuer to make a decision regarding the payment of A's claim, the 
conclusion in Example 1 in 29 CFR 2590.702-1(e) or 45 CFR 146.122(e) 
concludes that the issuer's request for the results of the genetic test 
violates paragraph (c) of 29 CFR 2590.702-1 or 45 CFR 146.122 similar to 
paragraph (c) of this section.
    Example 2. (i) Facts. Individual B's group health plan covers a 
yearly mammogram for participants and beneficiaries starting at age 40, 
or at age 30 for those with increased risk for breast cancer, including 
individuals with BRCA1 or BRCA2 gene mutations. B is 33 years old and 
has the BRCA2 mutation. B undergoes a mammogram and promptly submits a 
claim to B's plan for reimbursement. Following an established policy, 
the plan asks B for evidence of increased risk of breast cancer, such as 
the results of a genetic test or a family history of breast cancer, 
before the claim for the mammogram is paid. This policy is applied 
uniformly to all similarly situated individuals and is not directed at 
individuals based on any genetic information.
    (ii) Conclusion. In this Example 2, the plan does not violate 
paragraphs (c) or (d) of this section. Under paragraph (c), the plan is 
permitted to request and use the results of a genetic test to make a 
determination regarding payment, provided the plan requests only the 
minimum amount of information necessary. Because the medical 
appropriateness of the mammogram depends on the genetic makeup of the 
patient, the minimum amount of information necessary includes the 
results of the genetic test. Similarly, the plan does not violate 
paragraph (d) of this section because the plan is permitted to request 
genetic information in making a determination regarding the medical 
appropriateness of a claim if the genetic information is necessary to 
make the determination (and if the genetic information is not used for 
underwriting purposes).
    Example 3. (i) Facts. Individual C was previously diagnosed with and 
treated for breast cancer, which is currently in remission. In 
accordance with the recommendation of C's physician, C has been taking a 
regular dose of tamoxifen to help prevent a recurrence. C's group health 
plan adopts a new policy requiring patients taking tamoxifen to undergo 
a genetic test to ensure that tamoxifen is medically appropriate for 
their genetic makeup. In accordance with, at the time, the latest 
scientific research, tamoxifen is not helpful in up to 7 percent of 
breast cancer patients, those with certain variations of the gene for 
making the CYP2D6 enzyme. If a patient has a gene variant 
making tamoxifen not medically appropriate, the plan does not pay for 
the tamoxifen prescription.
    (ii) Conclusion. In this Example 3, the plan does not violate 
paragraph (c) of this section if it conditions future payments for the 
tamoxifen prescription on C's undergoing a genetic test to determine 
what genetic markers C has for making the CYP2D6 enzyme. Nor 
does the plan violate paragraph (c) of this section if the plan refuses 
future payment if the results of the genetic test indicate that 
tamoxifen is not medically appropriate for C.
    Example 4. (i) Facts. A group health plan offers a diabetes disease 
management program to all similarly situated individuals for whom it is 
medically appropriate based on whether the individuals have or are at 
risk for diabetes. The program provides enhanced benefits related only 
to diabetes for individuals who qualify for the program. The plan sends 
out a notice to all participants that describes the diabetes disease 
management program and explains the terms for eligibility. Individuals 
interested in enrolling in the program are advised to contact the plan 
to demonstrate that they have diabetes or that they are at risk for 
diabetes. For individuals who do not currently have diabetes, genetic 
information may be used to demonstrate that an individual is at risk.
    (ii) Conclusion. In this Example 4, the plan may condition benefits 
under the disease management program upon a showing by an individual 
that the individual is at risk for diabetes, even if such showing may 
involve genetic information, provided that the plan requests genetic 
information only when necessary to make a determination regarding 
whether the disease management program is medically appropriate for the 
individual and only requests the minimum amount of information necessary 
to make that determination.
    Example 5. (i) Facts. Same facts as Example 4, except that the plan 
includes a questionnaire that asks about the occurrence of diabetes in 
members of the individual's family

[[Page 456]]

as part of the notice describing the disease management program.
    (ii) Conclusion. In this Example 5, the plan violates the 
requirements of paragraph (d)(1) of this section because the requests 
for genetic information are not limited to those situations in which it 
is necessary to make a determination regarding whether the disease 
management program is medically appropriate for the individuals.
    Example 6. (i) Facts. Same facts as Example 4, except the disease 
management program provides an enhanced benefit in the form of a lower 
annual deductible to individuals under the program; the lower deductible 
applies with respect to all medical expenses incurred by the individual. 
Thus, whether or not a claim relates to diabetes, the individual is 
provided with a lower deductible based on the individual providing the 
plan with genetic information.
    (ii) Conclusion. In this Example 6, because the enhanced benefits 
include benefits not related to the determination of medical 
appropriateness, making available the enhanced benefits is within the 
meaning of underwriting purposes. Accordingly, the plan may not request 
or require genetic information (including family history information) in 
determining eligibility for enhanced benefits under the program because 
such a request would be for underwriting purposes and would violate 
paragraph (d)(1) of this section.

    (f) Effective/applicability date. This section applies for plan 
years beginning on or after December 7, 2009.
    (g) Expiration date. This section expires on or before October 1, 
2012.

[T.D. 9464, 74 FR 51678, Oct. 7, 2009]



Sec. 54.9811-1  Standards relating to benefits for mothers and newborns.

    (a) Hospital length of stay--(1) General rule. Except as provided in 
paragraph (a)(5) of this section, a group health plan that provides 
benefits for a hospital length of stay in connection with childbirth for 
a mother or her newborn may not restrict benefits for the stay to less 
than--
    (i) 48 hours following a vaginal delivery; or
    (ii) 96 hours following a delivery by cesarean section.
    (2) When stay begins--(i) Delivery in a hospital. If delivery occurs 
in a hospital, the hospital length of stay for the mother or newborn 
child begins at the time of delivery (or in the case of multiple births, 
at the time of the last delivery).
    (ii) Delivery outside a hospital. If delivery occurs outside a 
hospital, the hospital length of stay begins at the time the mother or 
newborn is admitted as a hospital inpatient in connection with 
childbirth. The determination of whether an admission is in connection 
with childbirth is a medical decision to be made by the attending 
provider.
    (3) Examples. The rules of paragraphs (a)(1) and (2) of this section 
are illustrated by the following examples. In each example, the group 
health plan provides benefits for hospital lengths of stay in connection 
with childbirth and is subject to the requirements of this section, as 
follows:

    Example 1. (i) Facts. A pregnant woman covered under a group health 
plan goes into labor and is admitted to the hospital at 10 p.m. on June 
11. She gives birth by vaginal delivery at 6 a.m. on June 12.
    (ii) Conclusion. In this Example 1, the 48-hour period described in 
paragraph (a)(1)(i) of this section ends at 6 a.m. on June 14.
    Example 2. (i) Facts. A woman covered under a group health plan 
gives birth at home by vaginal delivery. After the delivery, the woman 
begins bleeding excessively in connection with the childbirth and is 
admitted to the hospital for treatment of the excessive bleeding at 7 
p.m. on October 1.
    (ii) Conclusion. In this Example 2, the 48-hour period described in 
paragraph (a)(1)(i) of this section ends at 7 p.m. on October 3.
    Example 3. (i) Facts. A woman covered under a group health plan 
gives birth by vaginal delivery at home. The child later develops 
pneumonia and is admitted to the hospital. The attending provider 
determines that the admission is not in connection with childbirth.
    (ii) Conclusion. In this Example 3, the hospital length-of-stay 
requirements of this section do not apply to the child's admission to 
the hospital because the admission is not in connection with childbirth.

    (4) Authorization not required--(i) In general. A plan may not 
require that a physician or other health care provider obtain 
authorization from the plan, or from a health insurance issuer offering 
health insurance coverage under the plan, for prescribing the hospital 
length of stay specified in paragraph (a)(1) of this section. (See also 
paragraphs (b)(2) and (c)(3) of this section for rules and examples 
regarding other authorization and certain notice requirements.)

[[Page 457]]

    (ii) Example. The rule of this paragraph (a)(4) is illustrated by 
the following example:

    Example. (i) Facts. In the case of a delivery by cesarean section, a 
group health plan subject to the requirements of this section 
automatically provides benefits for any hospital length of stay of up to 
72 hours. For any longer stay, the plan requires an attending provider 
to complete a certificate of medical necessity. The plan then makes a 
determination, based on the certificate of medical necessity, whether a 
longer stay is medically necessary.
    (ii) Conclusion. In this Example, the requirement that an attending 
provider complete a certificate of medical necessity to obtain 
authorization for the period between 72 hours and 96 hours following a 
delivery by cesarean section is prohibited by this paragraph (a)(4).

    (5) Exceptions--(i) Discharge of mother. If a decision to discharge 
a mother earlier than the period specified in paragraph (a)(1) of this 
section is made by an attending provider, in consultation with the 
mother, the requirements of paragraph (a)(1) of this section do not 
apply for any period after the discharge.
    (ii) Discharge of newborn. If a decision to discharge a newborn 
child earlier than the period specified in paragraph (a)(1) of this 
section is made by an attending provider, in consultation with the 
mother (or the newborn's authorized representative), the requirements of 
paragraph (a)(1) of this section do not apply for any period after the 
discharge.
    (iii) Attending provider defined. For purposes of this section, 
attending provider means an individual who is licensed under applicable 
state law to provide maternity or pediatric care and who is directly 
responsible for providing maternity or pediatric care to a mother or 
newborn child. Therefore, a plan, hospital, managed care organization, 
or other issuer is not an attending provider.
    (iv) Example. The rules of this paragraph (a)(5) are illustrated by 
the following example:

    Example. (i) Facts. A pregnant woman covered under a group health 
plan subject to the requirements of this section goes into labor and is 
admitted to a hospital. She gives birth by cesarean section. On the 
third day after the delivery, the attending provider for the mother 
consults with the mother, and the attending provider for the newborn 
consults with the mother regarding the newborn. The attending providers 
authorize the early discharge of both the mother and the newborn. Both 
are discharged approximately 72 hours after the delivery. The plan pays 
for the 72-hour hospital stays.
    (ii) Conclusion. In this Example, the requirements of this paragraph 
(a) have been satisfied with respect to the mother and the newborn. If 
either is readmitted, the hospital stay for the readmission is not 
subject to this section.

    (b) Prohibitions--(1) With respect to mothers--(i) In general. A 
group health plan may not--
    (A) Deny a mother or her newborn child eligibility or continued 
eligibility to enroll or renew coverage under the terms of the plan 
solely to avoid the requirements of this section; or
    (B) Provide payments (including payments-in-kind) or rebates to a 
mother to encourage her to accept less than the minimum protections 
available under this section.
    (ii) Examples. The rules of this paragraph (b)(1) are illustrated by 
the following examples. In each example, the group health plan is 
subject to the requirements of this section, as follows:

    Example 1. (i) Facts. A group health plan provides benefits for at 
least a 48-hour hospital length of stay following a vaginal delivery. If 
a mother and newborn covered under the plan are discharged within 24 
hours after the delivery, the plan will waive the copayment and 
deductible.
    (ii) Conclusion. In this Example 1, because waiver of the copayment 
and deductible is in the nature of a rebate that the mother would not 
receive if she and her newborn remained in the hospital, it is 
prohibited by this paragraph (b)(1). (In addition, the plan violates 
paragraph (b)(2) of this section because, in effect, no copayment or 
deductible is required for the first portion of the stay and a double 
copayment and a deductible are required for the second portion of the 
stay.)
    Example 2. (i) Facts. A group health plan provides benefits for at 
least a 48-hour hospital length of stay following a vaginal delivery. In 
the event that a mother and her newborn are discharged earlier than 48 
hours and the discharges occur after consultation with the mother in 
accordance with the requirements of paragraph (a)(5) of this section, 
the plan provides for a follow-up visit by a nurse within 48 hours after 
the discharges to provide certain services that the mother and her 
newborn would otherwise receive in the hospital.

[[Page 458]]

    (ii) Conclusion. In this Example 2, because the follow-up visit does 
not provide any services beyond what the mother and her newborn would 
receive in the hospital, coverage for the follow-up visit is not 
prohibited by this paragraph (b)(1).

    (2) With respect to benefit restrictions--(i) In general. Subject to 
paragraph (c)(3) of this section, a group health plan may not restrict 
the benefits for any portion of a hospital length of stay specified in 
paragraph (a) of this section in a manner that is less favorable than 
the benefits provided for any preceding portion of the stay.
    (ii) Example. The rules of this paragraph (b)(2) are illustrated by 
the following example:

    Example. (i) Facts. A group health plan subject to the requirements 
of this section provides benefits for hospital lengths of stay in 
connection with childbirth. In the case of a delivery by cesarean 
section, the plan automatically pays for the first 48 hours. With 
respect to each succeeding 24-hour period, the participant or 
beneficiary must call the plan to obtain precertification from a 
utilization reviewer, who determines if an additional 24-hour period is 
medically necessary. If this approval is not obtained, the plan will not 
provide benefits for any succeeding 24-hour period.
    (ii) Conclusion. In this Example, the requirement to obtain 
precertification for the two 24-hour periods immediately following the 
initial 48-hour stay is prohibited by this paragraph (b)(2) because 
benefits for the latter part of the stay are restricted in a manner that 
is less favorable than benefits for a preceding portion of the stay. 
(However, this section does not prohibit a plan from requiring 
precertification for any period after the first 96 hours.) In addition, 
the requirement to obtain precertification from the plan based on 
medical necessity for a hospital length of stay within the 96-hour 
period would also violate paragraph (a) of this section.

    (3) With respect to attending providers. A group health plan may not 
directly or indirectly--
    (i) Penalize (for example, take disciplinary action against or 
retaliate against), or otherwise reduce or limit the compensation of, an 
attending provider because the provider furnished care to a participant 
or beneficiary in accordance with this section; or
    (ii) Provide monetary or other incentives to an attending provider 
to induce the provider to furnish care to a participant or beneficiary 
in a manner inconsistent with this section, including providing any 
incentive that could induce an attending provider to discharge a mother 
or newborn earlier than 48 hours (or 96 hours) after delivery.
    (c) Construction. With respect to this section, the following rules 
of construction apply:
    (1) Hospital stays not mandatory. This section does not require a 
mother to--
    (i) Give birth in a hospital; or
    (ii) Stay in the hospital for a fixed period of time following the 
birth of her child.
    (2) Hospital stay benefits not mandated. This section does not apply 
to any group health plan that does not provide benefits for hospital 
lengths of stay in connection with childbirth for a mother or her 
newborn child.
    (3) Cost-sharing rules--(i) In general. This section does not 
prevent a group health plan from imposing deductibles, coinsurance, or 
other cost-sharing in relation to benefits for hospital lengths of stay 
in connection with childbirth for a mother or a newborn under the plan 
or coverage, except that the coinsurance or other cost-sharing for any 
portion of the hospital length of stay specified in paragraph (a) of 
this section may not be greater than that for any preceding portion of 
the stay.
    (ii) Examples. The rules of this paragraph (c)(3) are illustrated by 
the following examples. In each example, the group health plan is 
subject to the requirements of this section, as follows:

    Example 1. (i) Facts. A group health plan provides benefits for at 
least a 48-hour hospital length of stay in connection with vaginal 
deliveries. The plan covers 80 percent of the cost of the stay for the 
first 24-hour period and 50 percent of the cost of the stay for the 
second 24-hour period. Thus, the coinsurance paid by the patient 
increases from 20 percent to 50 percent after 24 hours.
    (ii) Conclusion. In this Example 1, the plan violates the rules of 
this paragraph (c)(3) because coinsurance for the second 24-hour period 
of the 48-hour stay is greater than that for the preceding portion of 
the stay. (In addition, the plan also violates the similar rule in 
paragraph (b)(2) of this section.)
    Example 2. (i) Facts. A group health plan generally covers 70 
percent of the cost of a hospital length of stay in connection with 
childbirth. However, the plan will cover 80 percent of the cost of the 
stay if the participant or beneficiary notifies the plan of the

[[Page 459]]

pregnancy in advance of admission and uses whatever hospital the plan 
may designate.
    (ii) Conclusion. In this Example 2, the plan does not violate the 
rules of this paragraph (c)(3) because the level of benefits provided 
(70 percent or 80 percent) is consistent throughout the 48-hour (or 96-
hour) hospital length of stay required under paragraph (a) of this 
section. (In addition, the plan does not violate the rules in paragraph 
(a)(4) or (b)(2) of this section.)

    (4) Compensation of attending provider. This section does not 
prevent a group health plan from negotiating with an attending provider 
the level and type of compensation for care furnished in accordance with 
this section (including paragraph (b) of this section).
    (d) Notice requirement. See 29 CFR 2520.102-3(u) for rules relating 
to a disclosure requirement imposed under section 711(d) of ERISA (29 
U.S.C. 1181) on certain group health plans that provide benefits for 
hospital lengths of stay in connection with childbirth.
    (e) Applicability in certain states--(1) Health insurance coverage. 
The requirements of section 9811 and this section do not apply with 
respect to health insurance coverage offered in connection with a group 
health plan if there is a state law regulating the coverage that meets 
any of the following criteria:
    (i) The state law requires the coverage to provide for at least a 
48-hour hospital length of stay following a vaginal delivery and at 
least a 96-hour hospital length of stay following a delivery by cesarean 
section.
    (ii) The state law requires the coverage to provide for maternity 
and pediatric care in accordance with guidelines that relate to care 
following childbirth established by the American College of 
Obstetricians and Gynecologists, the American Academy of Pediatrics, or 
any other established professional medical association.
    (iii) The state law requires, in connection with the coverage for 
maternity care, that the hospital length of stay for such care is left 
to the decision of (or is required to be made by) the attending provider 
in consultation with the mother. State laws that require the decision to 
be made by the attending provider with the consent of the mother satisfy 
the criterion of this paragraph (e)(1)(iii).
    (2) Group health plans--(i) Fully-insured plans. For a group health 
plan that provides benefits solely through health insurance coverage, if 
the state law regulating the health insurance coverage meets any of the 
criteria in paragraph (e)(1) of this section, then the requirements of 
section 9811 and this section do not apply.
    (ii) Self-insured plans. For a group health plan that provides all 
benefits for hospital lengths of stay in connection with childbirth 
other than through health insurance coverage, the requirements of 
section 9811 and this section apply.
    (iii) Partially-insured plans. For a group health plan that provides 
some benefits through health insurance coverage, if the state law 
regulating the health insurance coverage meets any of the criteria in 
paragraph (e)(1) of this section, then the requirements of section 9811 
and this section apply only to the extent the plan provides benefits for 
hospital lengths of stay in connection with childbirth other than 
through health insurance coverage.
    (3) Preemption provisions under section 731(a) of ERISA. See 29 CFR 
2590.711(e)(3) for a rule providing that the preemption provisions 
contained in section 731(a)(1) of ERISA and 29 CFR 2590.731(a) do not 
supersede a state law if the state law is described in paragraph (e)(1) 
of 29 CFR 2590.711 (which is substantially similar to paragraph (e)(1) 
of this section).
    (4) Examples. The rules of this paragraph (e) are illustrated by the 
following examples:

    Example 1. (i) Facts. A group health plan buys group health 
insurance coverage in a state that requires that the coverage provide 
for at least a 48-hour hospital length of stay following a vaginal 
delivery and at least a 96-hour hospital length of stay following a 
delivery by cesarean section.
    (ii) Conclusion. In this Example 1, the coverage is subject to state 
law, and the requirements of section 9811 and this section do not apply.
    Example 2. (i) Facts. A self-insured group health plan covers 
hospital lengths of stay in connection with childbirth in a state that 
requires health insurance coverage to provide

[[Page 460]]

for maternity and pediatric care in accordance with guidelines that 
relate to care following childbirth established by the American College 
of Obstetricians and Gynecologists and the American Academy of 
Pediatrics.
    (ii) Conclusion. In this Example 2, even though the state law 
satisfies the criterion of paragraph (e)(1)(ii) of this section, because 
the plan provides benefits for hospital lengths of stay in connection 
with childbirth other than through health insurance coverage, the plan 
is subject to the requirements of section 9811 and this section.

    (f) Effective/applicability date. This section applies to group 
health plans for plan years beginning on or after January 1, 2009.

[T.D. 9427, 73 FR 62420, Oct. 20, 2008]



Sec. 54.9812-1T  Parity in mental health and substance use disorder 
benefits (temporary).

    (a) Meaning of terms. For purposes of this section, except where the 
context clearly indicates otherwise, the following terms have the 
meanings indicated:
    Aggregate lifetime dollar limit means a dollar limitation on the 
total amount of specified benefits that may be paid under a group health 
plan for any coverage unit.
    Annual dollar limit means a dollar limitation on the total amount of 
specified benefits that may be paid in a 12-month period under a group 
health plan for any coverage unit.
    Coverage unit means coverage unit as described in paragraph 
(c)(1)(iv) of this section.
    Cumulative financial requirements are financial requirements that 
determine whether or to what extent benefits are provided based on 
accumulated amounts and include deductibles and out-of-pocket maximums. 
(However, cumulative financial requirements do not include aggregate 
lifetime or annual dollar limits because these two terms are excluded 
from the meaning of financial requirements.)
    Cumulative quantitative treatment limitations are treatment 
limitations that determine whether or to what extent benefits are 
provided based on accumulated amounts, such as annual or lifetime day or 
visit limits.
    Financial requirements include deductibles, copayments, coinsurance, 
or out-of-pocket maximums. Financial requirements do not include 
aggregate lifetime or annual dollar limits.
    Medical/surgical benefits means benefits for medical or surgical 
services, as defined under the terms of the plan, but does not include 
mental health or substance use disorder benefits. Any condition defined 
by the plan as being or as not being a medical/surgical condition must 
be defined to be consistent with generally recognized independent 
standards of current medical practice (for example, the most current 
version of the International Classification of Diseases (ICD) or State 
guidelines).
    Mental health benefits means benefits with respect to services for 
mental health conditions, as defined under the terms of the plan and in 
accordance with applicable Federal and State law. Any condition defined 
by the plan as being or as not being a mental health condition must be 
defined to be consistent with generally recognized independent standards 
of current medical practice (for example, the most current version of 
the Diagnostic and Statistical Manual of Mental Disorders (DSM), the 
most current version of the ICD, or State guidelines).
    Substance use disorder benefits means benefits with respect to 
services for substance use disorders, as defined under the terms of the 
plan and in accordance with applicable Federal and State law. Any 
disorder defined by the plan as being or as not being a substance use 
disorder must be defined to be consistent with generally recognized 
independent standards of current medical practice (for example, the most 
current version of the DSM, the most current version of the ICD, or 
State guidelines).
    Treatment limitations include limits on benefits based on the 
frequency of treatment, number of visits, days of coverage, days in a 
waiting period, or other similar limits on the scope or duration of 
treatment. Treatment limitations include both quantitative treatment 
limitations, which are expressed numerically (such as 50 outpatient 
visits per year), and nonquantitative treatment limitations, which 
otherwise limit the scope or duration of benefits

[[Page 461]]

for treatment under a plan. (See paragraph (c)(4)(ii) of this section 
for an illustrative list of nonquantitative treatment limitations.) A 
permanent exclusion of all benefits for a particular condition or 
disorder, however, is not a treatment limitation.
    (b) Parity requirements with respect to aggregate lifetime and 
annual dollar limits--(1) General--(i) General parity requirement. A 
group health plan that provides both medical/surgical benefits and 
mental health or substance use disorder benefits must comply with 
paragraph (b)(2), (b)(3), or (b)(6) of this section.
    (ii) Exception. The rule in paragraph (b)(1)(i) of this section does 
not apply if a plan satisfies the requirements of paragraph (f) or (g) 
of this section (relating to exemptions for small employers and for 
increased cost).
    (2) Plan with no limit or limits on less than one-third of all 
medical/surgical benefits. If a plan does not include an aggregate 
lifetime or annual dollar limit on any medical/surgical benefits or 
includes an aggregate lifetime or annual dollar limit that applies to 
less than one-third of all medical/surgical benefits, it may not impose 
an aggregate lifetime or annual dollar limit, respectively, on mental 
health or substance use disorder benefits.
    (3) Plan with a limit on at least two-thirds of all medical/surgical 
benefits. If a plan includes an aggregate lifetime or annual dollar 
limit on at least two-thirds of all medical/surgical benefits, it must 
either--
    (i) Apply the aggregate lifetime or annual dollar limit both to the 
medical/surgical benefits to which the limit would otherwise apply and 
to mental health or substance use disorder benefits in a manner that 
does not distinguish between the medical/surgical benefits and mental 
health or substance use disorder benefits; or
    (ii) Not include an aggregate lifetime or annual dollar limit on 
mental health or substance use disorder benefits that is less than the 
aggregate lifetime or annual dollar limit, respectively, on medical/
surgical benefits. (For cumulative limits other than aggregate lifetime 
or annual dollar limits, see paragraph (c)(3)(v) of this section 
prohibiting separately accumulating cumulative financial requirements or 
cumulative quantitative treatment limitations.)

    (4) Examples. The rules of paragraphs (b)(2) and (b)(3) of this 
section are illustrated by the following examples:

    Example 1. (i) Facts. A group health plan has no annual limit on 
medical/surgical benefits and a $10,000 annual limit on mental health 
and substance use disorder benefits. To comply with the requirements of 
this paragraph (b), the plan sponsor is considering each of the 
following options:
    (A) Eliminating the plan's annual dollar limit on mental health and 
substance use disorder benefits;
    (B) Replacing the plan's annual dollar limit on mental health and 
substance use disorder benefits with a $500,000 annual limit on all 
benefits (including medical/surgical and mental health and substance use 
disorder benefits); and
    (C) Replacing the plan's annual dollar limit on mental health and 
substance use disorder benefits with a $250,000 annual limit on medical/
surgical benefits and a $250,000 annual limit on mental health and 
substance use disorder benefits.
    (ii) Conclusion. In this Example 1, each of the three options being 
considered by the plan sponsor would comply with the requirements of 
this paragraph (b).
    Example 2. (i) Facts. A plan has a $100,000 annual limit on medical/
surgical inpatient benefits and a $50,000 annual limit on medical/
surgical outpatient benefits. To comply with the parity requirements of 
this paragraph (b), the plan sponsor is considering each of the 
following options:
    (A) Imposing a $150,000 annual limit on mental health and substance 
use disorder benefits; and
    (B) Imposing a $100,000 annual limit on mental health and substance 
use disorder inpatient benefits and a $50,000 annual limit on mental 
health and substance use disorder outpatient benefits.
    (ii) Conclusion. In this Example 2, each option under consideration 
by the plan sponsor would comply with the requirements of this section.

    (5) Determining one-third and two-thirds of all medical/surgical 
benefits. For purposes of this paragraph (b), the determination of 
whether the portion of medical/surgical benefits subject to an aggregate 
lifetime or annual dollar limit represents one-third or two-thirds of 
all medical/surgical benefits is based on the dollar amount of all plan 
payments for medical/surgical benefits expected to be paid under the

[[Page 462]]

plan for the plan year (or for the portion of the plan year after a 
change in plan benefits that affects the applicability of the aggregate 
lifetime or annual dollar limits). Any reasonable method may be used to 
determine whether the dollar amount expected to be paid under the plan 
will constitute one-third or two-thirds of the dollar amount of all plan 
payments for medical/surgical benefits.
    (6) Plan not described in paragraph (b)(2) or (b)(3) of this 
section--(i) In general. A group health plan that is not described in 
paragraph (b)(2) or (b)(3) of this section with respect to aggregate 
lifetime or annual dollar limits on medical/surgical benefits, must 
either--
    (A) Impose no aggregate lifetime or annual dollar limit, as 
appropriate, on mental health or substance use disorder benefits; or
    (B) Impose an aggregate lifetime or annual dollar limit on mental 
health or substance use disorder benefits that is no less than an 
average limit calculated for medical/surgical benefits in the following 
manner. The average limit is calculated by taking into account the 
weighted average of the aggregate lifetime or annual dollar limits, as 
appropriate, that are applicable to the categories of medical/surgical 
benefits. Limits based on delivery systems, such as inpatient/outpatient 
treatment or normal treatment of common, low-cost conditions (such as 
treatment of normal births), do not constitute categories for purposes 
of this paragraph (b)(6)(i)(B). In addition, for purposes of determining 
weighted averages, any benefits that are not within a category that is 
subject to a separately-designated dollar limit under the plan are taken 
into account as a single separate category by using an estimate of the 
upper limit on the dollar amount that a plan may reasonably be expected 
to incur with respect to such benefits, taking into account any other 
applicable restrictions under the plan.
    (ii) Weighting. For purposes of this paragraph (b)(6), the weighting 
applicable to any category of medical/surgical benefits is determined in 
the manner set forth in paragraph (b)(5) of this section for determining 
one-third or two-thirds of all medical/surgical benefits.
    (iii) Example. The rules of this paragraph (b)(6) are illustrated by 
the following example:

    Example. (i) Facts. A group health plan that is subject to the 
requirements of this section includes a $100,000 annual limit on 
medical/surgical benefits related to cardio-pulmonary diseases. The plan 
does not include an annual dollar limit on any other category of 
medical/surgical benefits. The plan determines that 40 percent of the 
dollar amount of plan payments for medical/surgical benefits are related 
to cardio-pulmonary diseases. The plan determines that $1,000,000 is a 
reasonable estimate of the upper limit on the dollar amount that the 
plan may incur with respect to the other 60 percent of payments for 
medical/surgical benefits.
    (ii) Conclusion. In this Example, the plan is not described in 
paragraph (b)(3) of this section because there is not one annual dollar 
limit that applies to at least two-thirds of all medical/surgical 
benefits. Further, the plan is not described in paragraph (b)(2) of this 
section because more than one-third of all medical/surgical benefits are 
subject to an annual dollar limit. Under this paragraph (b)(6), the plan 
sponsor can choose either to include no annual dollar limit on mental 
health or substance use disorder benefits, or to include an annual 
dollar limit on mental health or substance use disorder benefits that is 
not less than the weighted average of the annual dollar limits 
applicable to each category of medical/surgical benefits. In this 
example, the minimum weighted average annual dollar limit that can be 
applied to mental health or substance use disorder benefits is $640,000 
(40% x $100,000 + 60% x $1,000,000 = $640,000).

    (c) Parity requirements with respect to financial requirements and 
treatment limitations--(1) Clarification of terms--(i) Classification of 
benefits. When reference is made in this paragraph (c) to a 
classification of benefits, the term ``classification'' means a 
classification as described in paragraph (c)(2)(ii) of this section.
    (ii) Type of financial requirement or treatment limitation. When 
reference is made in this paragraph (c) to a type of financial 
requirement or treatment limitation, the reference to type means its 
nature. Different types of financial requirements include deductibles, 
copayments, coinsurance, and out-of-pocket maximums. Different types of 
quantitative treatment limitations include annual, episode, and lifetime 
day

[[Page 463]]

and visit limits. See paragraph (c)(4)(ii) of this section for an 
illustrative list of nonquantitative treatment limitations.
    (iii) Level of a type of financial requirement or treatment 
limitation. When reference is made in this paragraph (c) to a level of a 
type of financial requirement or treatment limitation, level refers to 
the magnitude of the type of financial requirement or treatment 
limitation. For example, different levels of coinsurance include 20 
percent and 30 percent; different levels of a copayment include $15 and 
$20; different levels of a deductible include $250 and $500; and 
different levels of an episode limit include 21 inpatient days per 
episode and 30 inpatient days per episode.
    (iv) Coverage unit. When reference is made in this paragraph (c) to 
a coverage unit, coverage unit refers to the way in which a plan groups 
individuals for purposes of determining benefits, or premiums or 
contributions. For example, different coverage units include self-only, 
family, and employee-plus-spouse.
    (2) General parity requirement--(i) General rule. A group health 
plan that provides both medical/surgical benefits and mental health or 
substance use disorder benefits may not apply any financial requirement 
or treatment limitation to mental health or substance use disorder 
benefits in any classification that is more restrictive than the 
predominant financial requirement or treatment limitation of that type 
applied to substantially all medical/surgical benefits in the same 
classification. Whether a financial requirement or treatment limitation 
is a predominant financial requirement or treatment limitation that 
applies to substantially all medical/surgical benefits in a 
classification is determined separately for each type of financial 
requirement or treatment limitation. The application of the rules of 
this paragraph (c)(2) to financial requirements and quantitative 
treatment limitations is addressed in paragraph (c)(3) of this section; 
the application of the rules of this paragraph (c)(2) to nonquantitative 
treatment limitations is addressed in paragraph (c)(4) of this section.
    (ii) Classifications of benefits used for applying rules--(A) In 
general. If a plan provides mental health or substance use disorder 
benefits in any classification of benefits described in this paragraph 
(c)(2)(ii), mental health or substance use disorder benefits must be 
provided in every classification in which medical/surgical benefits are 
provided. In determining the classification in which a particular 
benefit belongs, a plan must apply the same standards to medical/
surgical benefits and to mental health or substance use disorder 
benefits. To the extent that a plan provides benefits in a 
classification and imposes any separate financial requirement or 
treatment limitation (or separate level of a financial requirement or 
treatment limitation) for benefits in the classification, the rules of 
this paragraph (c) apply separately with respect to that classification 
for all financial requirements or treatment limitations. The following 
classifications of benefits are the only classifications used in 
applying the rules of this paragraph (c):
    (1) Inpatient, in-network. Benefits furnished on an inpatient basis 
and within a network of providers established or recognized under a 
plan.
    (2) Inpatient, out-of-network. Benefits furnished on an inpatient 
basis and outside any network of providers established or recognized 
under a plan. This classification includes inpatient benefits under a 
plan that has no network of providers.
    (3) Outpatient, in-network. Benefits furnished on an outpatient 
basis and within a network of providers established or recognized under 
a plan.
    (4) Outpatient, out-of-network. Benefits furnished on an outpatient 
basis and outside any network of providers established or recognized 
under a plan. This classification includes outpatient benefits under a 
plan that has no network of providers.
    (5) Emergency care. Benefits for emergency care.
    (6) Prescription drugs. Benefits for prescription drugs. See special 
rules for multi-tiered prescription drug benefits in paragraph 
(c)(3)(iii) of this section.
    (B) Application to out-of-network providers. See paragraph 
(c)(2)(ii)(A) of this section, under which a plan that provides mental 
health or substance

[[Page 464]]

use disorder benefits in any classification of benefits must provide 
mental health or substance use disorder benefits in every classification 
in which medical/surgical benefits are provided, including out-of-
network classifications.
    (C) Examples. The rules of this paragraph (c)(2)(ii) are illustrated 
by the following examples. In each example, the group health plan is 
subject to the requirements of this section and provides both medical/
surgical benefits and mental health and substance use disorder benefits.

    Example 1. (i) Facts. A group health plan offers inpatient and 
outpatient benefits and does not contract with a network of providers. 
The plan imposes a $500 deductible on all benefits. For inpatient 
medical/surgical benefits, the plan imposes a coinsurance requirement. 
For outpatient medical/surgical benefits, the plan imposes copayments. 
The plan imposes no other financial requirements or treatment 
limitations.
    (ii) Conclusion. In this Example 1, because the plan has no network 
of providers, all benefits provided are out-of-network. Because 
inpatient, out-of-network medical/surgical benefits are subject to 
separate financial requirements from outpatient, out-of-network medical/
surgical benefits, the rules of this paragraph (c) apply separately with 
respect to any financial requirements and treatment limitations, 
including the deductible, in each classification.
    Example 2. (i) Facts. A plan imposes a $500 deductible on all 
benefits. The plan has no network of providers. The plan generally 
imposes a 20 percent coinsurance requirement with respect to all 
benefits, without distinguishing among inpatient, outpatient, emergency, 
or prescription drug benefits. The plan imposes no other financial 
requirements or treatment limitations.
    (ii) Conclusion. In this Example 2, because the plan does not impose 
separate financial requirements (or treatment limitations) based on 
classification, the rules of this paragraph (c) apply with respect to 
the deductible and the coinsurance across all benefits.
    Example 3. (i) Facts. Same facts as Example 2, except the plan 
exempts emergency care benefits from the 20 percent coinsurance 
requirement. The plan imposes no other financial requirements or 
treatment limitations.
    (ii) Conclusion. In this Example 3, because the plan imposes 
separate financial requirements based on classifications, the rules of 
this paragraph (c) apply with respect to the deductible and the 
coinsurance separately for--
    (A) Benefits in the emergency classification; and
    (B) All other benefits.
    Example 4. (i) Facts. Same facts as Example 2, except the plan also 
imposes a preauthorization requirement for all inpatient treatment in 
order for benefits to be paid. No such requirement applies to outpatient 
treatment.
    (ii) Conclusion. In this Example 4, because the plan has no network 
of providers, all benefits provided are out-of-network. Because the plan 
imposes a separate treatment limitation based on classifications, the 
rules of this paragraph (c) apply with respect to the deductible and 
coinsurance separately for--
    (A) Inpatient, out-of-network benefits; and
    (B) All other benefits.

    (3) Financial requirements and quantitative treatment limitations--
(i) Determining ``substantially all'' and ``predominant''--(A) 
Substantially all. For purposes of this paragraph (c), a type of 
financial requirement or quantitative treatment limitation is considered 
to apply to substantially all medical/surgical benefits in a 
classification of benefits if it applies to at least two-thirds of all 
medical/surgical benefits in that classification. (For this purpose, 
benefits expressed as subject to a zero level of a type of financial 
requirement are treated as benefits not subject to that type of 
financial requirement, and benefits expressed as subject to a 
quantitative treatment limitation that is unlimited are treated as 
benefits not subject to that type of quantitative treatment limitation.) 
If a type of financial requirement or quantitative treatment limitation 
does not apply to at least two-thirds of all medical/surgical benefits 
in a classification, then that type cannot be applied to mental health 
or substance use disorder benefits in that classification.
    (B) Predominant--(1) If a type of financial requirement or 
quantitative treatment limitation applies to at least two-thirds of all 
medical/surgical benefits in a classification as determined under 
paragraph (c)(3)(i)(A) of this section, the level of the financial 
requirement or quantitative treatment limitation that is considered the 
predominant level of that type in a classification of benefits is the 
level that applies to more than one-half of medical/surgical benefits in 
that classification

[[Page 465]]

subject to the financial requirement or quantitative treatment 
limitation.
    (2) If, with respect to a type of financial requirement or 
quantitative treatment limitation that applies to at least two-thirds of 
all medical/surgical benefits in a classification, there is no single 
level that applies to more than one-half of medical/surgical benefits in 
the classification subject to the financial requirement or quantitative 
treatment limitation, the plan may combine levels until the combination 
of levels applies to more than one-half of medical/surgical benefits 
subject to the financial requirement or quantitative treatment 
limitation in the classification. The least restrictive level within the 
combination is considered the predominant level of that type in the 
classification. (For this purpose, a plan may combine the most 
restrictive levels first, with each less restrictive level added to the 
combination until the combination applies to more than one-half of the 
benefits subject to the financial requirement or treatment limitation.)
    (C) Portion based on plan payments. For purposes of this paragraph 
(c), the determination of the portion of medical/surgical benefits in a 
classification of benefits subject to a financial requirement or 
quantitative treatment limitation (or subject to any level of a 
financial requirement or quantitative treatment limitation) is based on 
the dollar amount of all plan payments for medical/surgical benefits in 
the classification expected to be paid under the plan for the plan year 
(or for the portion of the plan year after a change in plan benefits 
that affects the applicability of the financial requirement or 
quantitative treatment limitation).
    (D) Clarifications for certain threshold requirements. For any 
deductible, the dollar amount of plan payments includes all plan 
payments with respect to claims that would be subject to the deductible 
if it had not been satisfied. For any out-of-pocket maximum, the dollar 
amount of plan payments includes all plan payments associated with out-
of-pocket payments that are taken into account towards the out-of-pocket 
maximum as well as all plan payments associated with out-of-pocket 
payments that would have been made towards the out-of-pocket maximum if 
it had not been satisfied. Similar rules apply for any other thresholds 
at which the rate of plan payment changes.
    (E) Determining the dollar amount of plan payments. Subject to 
paragraph (c)(3)(i)(D) of this section, any reasonable method may be 
used to determine the dollar amount expected to be paid under a plan for 
medical/surgical benefits subject to a financial requirement or 
quantitative treatment limitation (or subject to any level of a 
financial requirement or quantitative treatment limitation).
    (ii) Application to different coverage units. If a plan applies 
different levels of a financial requirement or quantitative treatment 
limitation to different coverage units in a classification of medical/
surgical benefits, the predominant level that applies to substantially 
all medical/surgical benefits in the classification is determined 
separately for each coverage unit.
    (iii) Special rule for multi-tiered prescription drug benefits. If a 
plan applies different levels of financial requirements to different 
tiers of prescription drug benefits based on reasonable factors 
determined in accordance with the rules in paragraph (c)(4)(i) of this 
section (relating to requirements for nonquantitative treatment 
limitations) and without regard to whether a drug is generally 
prescribed with respect to medical/surgical benefits or with respect to 
mental health or substance use disorder benefits, the plan satisfies the 
parity requirements of this paragraph (c) with respect to prescription 
drug benefits. Reasonable factors include cost, efficacy, generic versus 
brand name, and mail order versus pharmacy pick-up.
    (iv) Examples. The rules of paragraphs (c)(3)(i), (c)(3)(ii), and 
(c)(3)(iii) of this section are illustrated by the following examples. 
In each example, the group health plan is subject to the requirements of 
this section and provides both medical/surgical benefits and mental 
health and substance use disorder benefits.

    Example 1. (i) Facts. For inpatient, out-of-network medical/surgical 
benefits, a group health plan imposes five levels of coinsurance. Using 
a reasonable method, the plan

[[Page 466]]

projects its payments for the upcoming year as follows:

--------------------------------------------------------------------------------------------------------------------------------------------------------
 
--------------------------------------------------------------------------------------------------------------------------------------------------------
Coinsurance rate................  0%                  10%                 15%                 20%                 30%                 Total
Projected payments..............  $200x               $100x               $450x               $100x               $150x               $1,000x
Percent of total plan costs.....  20%                 10%                 45%                 10%                 15%
Percent subject to coinsurance    N/A                 12.5%               56.25%              12.5%               18.75%              ..................
 level.                                               (100x/800x)         (450x/800x)         (100x/800x)         (150x/800x)
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The plan projects plan costs of $800x to be subject to coinsurance 
($100x + $450x + $100x + $150x = $800x). Thus, 80 percent ($800x/
$1,000x) of the benefits are projected to be subject to coinsurance, and 
56.25 percent of the benefits subject to coinsurance are projected to be 
subject to the 15 percent coinsurance level.
    (ii) Conclusion. In this Example 1, the two-thirds threshold of the 
substantially all standard is met for coinsurance because 80 percent of 
all inpatient, out-of-network medical/surgical benefits are subject to 
coinsurance. Moreover, the 15 percent coinsurance is the predominant 
level because it is applicable to more than one-half of inpatient, out-
of-network medical/surgical benefits subject to the coinsurance 
requirement. The plan may not impose any level of coinsurance with 
respect to inpatient, out-of-network mental health or substance use 
disorder benefits that is more restrictive than the 15 percent level of 
coinsurance.
    Example 2. (i) Facts. For outpatient, in-network medical/surgical 
benefits, a plan imposes five different copayment levels. Using a 
reasonable method, the plan projects payments for the upcoming year as 
follows:

--------------------------------------------------------------------------------------------------------------------------------------------------------
 
--------------------------------------------------------------------------------------------------------------------------------------------------------
Copayment amount................  $0                  $10                 $15                 $20                 $50                 Total
Projected payments..............  $200x               $200x               $200x               $300x               $100x               $1,000x
Percent of total plan costs.....  20%                 20%                 20%                 30%                 10%
Percent subject to copayments...  N/A                 25%                 25%                 37.5%               12.5%               ..................
                                                      (200x/800x)         (200x/800x)         (300x/800x)         (100x/800x)
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 467]]

    The plan projects plan costs of $800x to be subject to copayments 
($200x + $200x + $300x + $100x = $800x). Thus, 80 percent ($800x/
$1,000x) of the benefits are projected to be subject to a copayment.
    (ii) Conclusion. In this Example 2, the two-thirds threshold of the 
substantially all standard is met for copayments because 80 percent of 
all outpatient, in-network medical/surgical benefits are subject to a 
copayment. Moreover, there is no single level that applies to more than 
one-half of medical/surgical benefits in the classification subject to a 
copayment (for the $10 copayment, 25 percent; for the $15 copayment, 25 
percent; for the $20 copayment, 37.5 percent; and for the $50 copayment, 
12.5 percent). The plan can combine any levels of copayment, including 
the highest levels, to determine the predominant level that can be 
applied to mental health or substance use disorder benefits. If the plan 
combines the highest levels of copayment, the combined projected 
payments for the two highest copayment levels, the $50 copayment and the 
$20 copayment, are not more than one-half of the outpatient, in-network 
medical/surgical benefits subject to a copayment because they are 
exactly one-half ($300x + $100x = $400x; $400x/$800x = 50%). The 
combined projected payments for the three highest copayment levels--the 
$50 copayment, the $20 copayment, and the $15 copayment--are more than 
one-half of the outpatient, in-network medical/surgical benefits subject 
to the copayments ($100x + $300x + $200x = $600x; $600x/$800x = 75%). 
Thus, the plan may not impose any copayment on outpatient, in-network 
mental health or substance use disorder benefits that is more 
restrictive than the least restrictive copayment in the combination, the 
$15 copayment.
    Example 3. (i) Facts. A plan imposes a $250 deductible on all 
medical/surgical benefits for self-only coverage and a $500 deductible 
on all medical/surgical benefits for family coverage. The plan has no 
network of providers. For all medical/surgical benefits, the plan 
imposes a coinsurance requirement. The plan imposes no other financial 
requirements or treatment limitations.
    (ii) Conclusion. In this Example 3, because the plan has no network 
of providers, all benefits are provided out-of-network. Because self-
only and family coverage are subject to different deductibles, whether 
the deductible applies to substantially all medical/surgical benefits is 
determined separately for self-only medical/surgical benefits and family 
medical/surgical benefits. Because the coinsurance is applied without 
regard to coverage units, the predominant coinsurance that applies to 
substantially all medical/surgical benefits is determined without regard 
to coverage units.
    Example 4. (i) Facts. A plan applies the following financial 
requirements for prescription drug benefits. The requirements are 
applied without regard to whether a drug is generally prescribed with 
respect to medical/surgical benefits or with respect to mental health or 
substance use disorder benefits. Moreover, the process for certifying a 
particular drug as ``generic'', ``preferred brand name'', ``non-
preferred brand name'', or ``specialty'' complies with the rules of 
paragraph (c)(4)(i) of this section (relating to requirements for 
nonquantitative treatment limitations).

----------------------------------------------------------------------------------------------------------------
                                            Tier 1             Tier 2             Tier 3             Tier 4
                                     ---------------------------------------------------------------------------
                                                                              Non-preferred
          Tier description                                                   brand name drugs
                                        Generic drugs     Preferred brand    (which may have    Specialty drugs
                                                             name drugs      Tier 1 or Tier 2
                                                                              alternatives)
----------------------------------------------------------------------------------------------------------------
Percent paid by plan................               90%                80%                60%                50%
----------------------------------------------------------------------------------------------------------------

    (ii) Conclusion. In this Example 4, the financial requirements that 
apply to prescription drug benefits are applied without regard to 
whether a drug is generally prescribed with respect to medical/surgical 
benefits or with respect to mental health or substance use disorder 
benefits; the process for certifying drugs in different tiers complies 
with paragraph (c)(4) of this section; and the bases for establishing 
different levels or types of financial requirements are reasonable. The 
financial requirements applied to prescription drug benefits do not 
violate the parity requirements of this paragraph (c)(3).

    (v) No separate cumulative financial requirements or cumulative 
quantitative treatment limitations. (A) A group health plan may not 
apply any cumulative financial requirement or cumulative quantitative 
treatment limitation for mental health or substance use disorder 
benefits in a classification that accumulates separately from any 
established for medical/surgical benefits in the same classification.
    (B) The rules of this paragraph (c)(3)(v) are illustrated by the 
following examples:


[[Page 468]]


    Example 1. (i) Facts. A group health plan imposes a combined annual 
$500 deductible on all medical/surgical, mental health, and substance 
use disorder benefits.
    (ii) Conclusion. In this Example 1, the combined annual deductible 
complies with the requirements of this paragraph (c)(3)(v).
    Example 2. (i) Facts. A plan imposes an annual $250 deductible on 
all medical/surgical benefits and a separate annual $250 deductible on 
all mental health and substance use disorder benefits.
    (ii) Conclusion. In this Example 2, the separate annual deductible 
on mental health and substance use disorder benefits violates the 
requirements of this paragraph (c)(3)(v).
    Example 3. (i) Facts. A plan imposes an annual $300 deductible on 
all medical/surgical benefits and a separate annual $100 deductible on 
all mental health or substance use disorder benefits.
    (ii) Conclusion. In this Example 3, the separate annual deductible 
on mental health and substance use disorder benefits violates the 
requirements of this paragraph (c)(3)(v).
    Example 4. (i) Facts. A plan generally imposes a combined annual 
$500 deductible on all benefits (both medical/surgical benefits and 
mental health and substance use disorder benefits) except prescription 
drugs. Certain benefits, such as preventive care, are provided without 
regard to the deductible. The imposition of other types of financial 
requirements or treatment limitations varies with each classification. 
Using reasonable methods, the plan projects its payments for medical/
surgical benefits in each classification for the upcoming year as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                            Benefits subject                     Percent subject
                      Classification                          to deductible    Total benefits     to deductible
----------------------------------------------------------------------------------------------------------------
Inpatient, in-network.....................................           $1,800x           $2,000x                90
Inpatient, out-of-network.................................            1,000x            1,000x               100
Outpatient, in-network....................................            1,400x            2,000x                70
Outpatient, out-of-network................................            1,880x            2,000x                94
Emergency care............................................              300x              500x                60
----------------------------------------------------------------------------------------------------------------

    (ii) Conclusion. In this Example 4, the two-thirds threshold of the 
substantially all standard is met with respect to each classification 
except emergency care because in each of those other classifications at 
least two-thirds of medical/surgical benefits are subject to the $500 
deductible. Moreover, the $500 deductible is the predominant level in 
each of those other classifications because it is the only level. 
However, emergency care mental health and substance use disorder 
benefits cannot be subject to the $500 deductible because it does not 
apply to substantially all emergency care medical/surgical benefits.

    (4) Nonquantitative treatment limitations--(i) General rule. A group 
health plan may not impose a nonquantitative treatment limitation with 
respect to mental health or substance use disorder benefits in any 
classification unless, under the terms of the plan as written and in 
operation, any processes, strategies, evidentiary standards, or other 
factors used in applying the nonquantitative treatment limitation to 
mental health or substance use disorder benefits in the classification 
are comparable to, and are applied no more stringently than, the 
processes, strategies, evidentiary standards, or other factors used in 
applying the limitation with respect to medical surgical/benefits in the 
classification, except to the extent that recognized clinically 
appropriate standards of care may permit a difference.
    (ii) Illustrative list of nonquantitative treatment limitations. 
Nonquantitative treatment limitations include--
    (A) Medical management standards limiting or excluding benefits 
based on medical necessity or medical appropriateness, or based on 
whether the treatment is experimental or investigative;
    (B) Formulary design for prescription drugs;
    (C) Standards for provider admission to participate in a network, 
including reimbursement rates;
    (D) Plan methods for determining usual, customary, and reasonable 
charges;
    (E) Refusal to pay for higher-cost therapies until it can be shown 
that a lower-cost therapy is not effective (also known as fail-first 
policies or step therapy protocols); and
    (F) Exclusions based on failure to complete a course of treatment.
    (iii) Examples. The rules of this paragraph (c)(4) are illustrated 
by the following examples. In each example, the group health plan is 
subject to the requirements of this section and provides both medical/
surgical benefits and

[[Page 469]]

mental health and substance use disorder benefits.

    Example 1. (i) Facts. A group health plan limits benefits to 
treatment that is medically necessary. The plan requires concurrent 
review for inpatient, in-network mental health and substance use 
disorder benefits but does not require it for any inpatient, in-network 
medical/surgical benefits. The plan conducts retrospective review for 
inpatient, in-network medical/surgical benefits.
    (ii) Conclusion. In this Example 1, the plan violates the rules of 
this paragraph (c)(4). Although the same nonquantitative treatment 
limitation--medical necessity--applies to both mental health and 
substance use disorder benefits and to medical/surgical benefits for 
inpatient, in-network services, the concurrent review process does not 
apply to medical/surgical benefits. The concurrent review process is not 
comparable to the retrospective review process. While such a difference 
might be permissible in certain individual cases based on recognized 
clinically appropriate standards of care, it is not permissible for 
distinguishing between all medical/surgical benefits and all mental 
health or substance use disorder benefits.
    Example 2. (i) Facts. A plan requires prior approval that a course 
of treatment is medically necessary for outpatient, in-network medical/
surgical, mental health, and substance use disorder benefits. For mental 
health and substance use disorder treatments that do not have prior 
approval, no benefits will be paid; for medical/surgical treatments that 
do not have prior approval, there will only be a 25 percent reduction in 
the benefits the plan would otherwise pay.
    (ii) Conclusion. In this Example 2, the plan violates the rules of 
this paragraph (c)(4). Although the same nonquantitative treatment 
limitation--medical necessity--is applied both to mental health and 
substance use disorder benefits and to medical/surgical benefits for 
outpatient, in-network services, the penalty for failure to obtain prior 
approval for mental health and substance use disorder benefits is not 
comparable to the penalty for failure to obtain prior approval for 
medical/surgical benefits.
    Example 3. (i) Facts. A plan generally covers medically appropriate 
treatments. For both medical/surgical benefits and mental health and 
substance use disorder benefits, evidentiary standards used in 
determining whether a treatment is medically appropriate (such as the 
number of visits or days of coverage) are based on recommendations made 
by panels of experts with appropriate training and experience in the 
fields of medicine involved. The evidentiary standards are applied in a 
manner that may differ based on clinically appropriate standards of care 
for a condition.
    (ii) Conclusion. In this Example 3, the plan complies with the rules 
of this paragraph (c)(4) because the nonquantitative treatment 
limitation--medical appropriateness--is the same for both medical/
surgical benefits and mental health and substance use disorder benefits, 
and the processes for developing the evidentiary standards and the 
application of them to mental health and substance use disorder benefits 
are comparable to and are applied no more stringently than for medical/
surgical benefits. This is the result even if, based on clinically 
appropriate standards of care, the application of the evidentiary 
standards does not result in similar numbers of visits, days of 
coverage, or other benefits utilized for mental health conditions or 
substance use disorders as it does for any particular medical/surgical 
condition.
    Example 4. (i) Facts. A plan generally covers medically appropriate 
treatments. In determining whether prescription drugs are medically 
appropriate, the plan automatically excludes coverage for antidepressant 
drugs that are given a black box warning label by the Food and Drug 
Administration (indicating the drug carries a significant risk of 
serious adverse effects). For other drugs with a black box warning 
(including those prescribed for other mental health conditions and 
substance use disorders, as well as for medical/surgical conditions), 
the plan will provide coverage if the prescribing physician obtains 
authorization from the plan that the drug is medically appropriate for 
the individual, based on clinically appropriate standards of care.
    (ii) Conclusion. In this Example 4, the plan violates the rules of 
this paragraph (c)(4). Although the same nonquantitative treatment 
limitation--medical appropriateness--is applied to both mental health 
and substance use disorder benefits and medical/surgical benefits, the 
plan's unconditional exclusion of antidepressant drugs given a black box 
warning is not comparable to the conditional exclusion for other drugs 
with a black box warning.
    Example 5. (i) Facts. An employer maintains both a major medical 
program and an employee assistance program (EAP). The EAP provides, 
among other benefits, a limited number of mental health or substance use 
disorder counseling sessions. Participants are eligible for mental 
health or substance use disorder benefits under the major medical 
program only after exhausting the counseling sessions provided by the 
EAP. No similar exhaustion requirement applies with respect to medical/
surgical benefits provided under the major medical program.
    (ii) Conclusion. In this Example 5, limiting eligibility for mental 
health and substance use disorder benefits only after EAP benefits are 
exhausted is a nonquantitative treatment limitation subject to the 
parity requirements of this paragraph (c). Because no

[[Page 470]]

comparable requirement applies to medical/surgical benefits, the 
requirement may not be applied to mental health or substance use 
disorder benefits.

    (5) Exemptions. The rules of this paragraph (c) do not apply if a 
group health plan satisfies the requirements of paragraph (f) or (g) of 
this section (relating to exemptions for small employers and for 
increased cost).
    (d) Availability of plan information--(1) Criteria for medical 
necessity determinations. The criteria for medical necessity 
determinations made under a group health plan with respect to mental 
health or substance use disorder benefits must be made available by the 
plan administrator to any current or potential participant, beneficiary, 
or contracting provider upon request.
    (2) Reason for denial. The reason for any denial under a group 
health plan of reimbursement or payment for services with respect to 
mental health or substance use disorder benefits in the case of any 
participant or beneficiary must be made available by the plan 
administrator to the participant or beneficiary in accordance with this 
paragraph (d)(2).
    (i) Plans subject to ERISA. If a plan is subject to ERISA, it must 
provide the reason for the claim denial in a form and manner consistent 
with the requirements of 29 CFR 2560.503-1 for group health plans.
    (ii) Plans not subject to ERISA. If a plan is not subject to ERISA, 
upon the request of a participant or beneficiary the reason for the 
claim denial must be provided within a reasonable time and in a 
reasonable manner. For this purpose, a plan that follows the 
requirements of 29 CFR 2560.503-1 for group health plans complies with 
the requirements of this paragraph (d)(2)(ii).
    (e) Applicability--(1) Group health plans. The requirements of this 
section apply to a group health plan offering medical/surgical benefits 
and mental health or substance use disorder benefits. If, under an 
arrangement or arrangements to provide health care benefits by an 
employer or employee organization (including for this purpose a joint 
board of trustees of a multiemployer trust affiliated with one or more 
multiemployer plans), any participant (or beneficiary) can 
simultaneously receive coverage for medical/surgical benefits and 
coverage for mental health or substance use disorder benefits, then the 
requirements of this section (including the exemption provisions in 
paragraph (g) of this section) apply separately with respect to each 
combination of medical/surgical benefits and of mental health or 
substance use disorder benefits that any participant (or beneficiary) 
can simultaneously receive from that employer's or employee 
organization's arrangement or arrangements to provide health care 
benefits, and all such combinations are considered for purposes of this 
section to be a single group health plan.
    (2) Health insurance issuers. See 29 CFR 2590.712(e)(2) and 45 CFR 
146.136(e)(2), under which a health insurance issuer offering health 
insurance coverage for mental health or substance use disorder benefits 
is subject to requirements similar to those applicable to group health 
plans under this section if the health insurance coverage is offered in 
connection with a group health plan subject to requirements under 29 CFR 
2590.712 or 45 CFR 146.136 similar to those applicable to group health 
plans under this section.
    (3) Scope. This section does not--
    (i) Require a group health plan to provide any mental health 
benefits or substance use disorder benefits, and the provision of 
benefits by a plan for one or more mental health conditions or substance 
use disorders does not require the plan under this section to provide 
benefits for any other mental health condition or substance use 
disorder; or
    (ii) Affect the terms and conditions relating to the amount, 
duration, or scope of mental health or substance use disorder benefits 
under the plan except as specifically provided in paragraphs (b) and (c) 
of this section.
    (f) Small employer exemption--(1) In general. The requirements of 
this section do not apply to a group health plan for a plan year of a 
small employer. For purposes of this paragraph (f), the term small 
employer means, in connection with a group health plan with respect to a 
calendar year and a plan year, an employer who employed an average of at 
least two (or one in

[[Page 471]]

the case of an employer residing in a state that permits small groups to 
include a single individual) but not more than 50 employees on business 
days during the preceding calendar year. See section 9831(a)(2) and 
Sec. 54.9831-1(b), which provide that this section (and certain other 
sections) does not apply to any group health plan for any plan year if, 
on the first day of the plan year, the plan has fewer than two 
participants who are current employees.
    (2) Rules in determining employer size. For purposes of paragraph 
(f)(1) of this section--
    (i) All persons treated as a single employer under subsections (b), 
(c), (m), and (o) of section 414 are treated as one employer;
    (ii) If an employer was not in existence throughout the preceding 
calendar year, whether it is a small employer is determined based on the 
average number of employees the employer reasonably expects to employ on 
business days during the current calendar year; and
    (iii) Any reference to an employer for purposes of the small 
employer exemption includes a reference to a predecessor of the 
employer.
    (g) Increased cost exemption [Reserved]
    (h) Sale of nonparity health insurance coverage. See 29 CFR 
2590.712(h) and 45 CFR 146.136(h), under which a health insurance issuer 
may not sell a policy, certificate, or contract of insurance that fails 
to comply with requirements similar to those under paragraph (b) or (c) 
of this section, except to a plan for a year for which the plan is 
exempt from requirements similar to those under paragraph (b) or (c) of 
this section because the plan meets requirements under paragraph (f) or 
(g) of 29 CFR 2590.712 or 45 CFR 146.136 similar to those under 
paragraph (f) or (g) of this section.
    (i) Effective/applicability dates--(1) In general. Except as 
provided in paragraph (i)(2) of this section, the requirements of this 
section are applicable for plan years beginning on or after July 1, 
2010.
    (2) Special effective date for certain collectively-bargained plans. 
For a group health plan maintained pursuant to one or more collective 
bargaining agreements ratified before October 3, 2008, the requirements 
of this section do not apply to the plan for plan years beginning before 
the later of either--
    (i) The date on which the last of the collective bargaining 
agreements relating to the plan terminates (determined without regard to 
any extension agreed to after October 3, 2008); or
    (ii) July 1, 2010.
    (j) Expiration date. This section expires on or before January 29, 
2013.

[T.D. 9479, 75 FR 5431, Feb. 2, 2010]



Sec. 54.9815-1251T  Preservation of right to maintain existing coverage
(temporary).

    (a) Definition of grandfathered health plan coverage--(1) In 
general--(i) Grandfathered health plan coverage. Grandfathered health 
plan coverage means coverage provided by a group health plan, or a 
health insurance issuer, in which an individual was enrolled on March 
23, 2010 (for as long as it maintains that status under the rules of 
this section). A group health plan or group health insurance coverage 
does not cease to be grandfathered health plan coverage merely because 
one or more (or even all) individuals enrolled on March 23, 2010 cease 
to be covered, provided that the plan has continuously covered someone 
since March 23, 2010 (not necessarily the same person, but at all times 
at least one person). In addition, subject to the limitation set forth 
in paragraph (a)(1)(ii) of this section, a group health plan (and any 
health insurance coverage offered in connection with the group health 
plan) does not cease to be a grandfathered health plan merely because 
the plan (or its sponsor) enters into a new policy, certificate, or 
contract of insurance after March 23, 2010 (for example, a plan enters 
into a contract with a new issuer or a new policy is issued with an 
existing issuer). For purposes of this section, a plan or health 
insurance coverage that provides grandfathered health plan coverage is 
referred to as a grandfathered health plan. The rules of this section 
apply separately to each benefit package made available under a group 
health plan or health insurance coverage.
    (ii) Changes in group health insurance coverage. Subject to 
paragraphs (f) and (g)(2) of this section, if a group health

[[Page 472]]

plan (including a group health plan that was self-insured on March 23, 
2010) or its sponsor enters into a new policy, certificate, or contract 
of insurance after March 23, 2010 that is effective before November 15, 
2010, then the plan ceases to be a grandfathered health plan.
    (2) Disclosure of grandfather status--(i) To maintain status as a 
grandfathered health plan, a plan or health insurance coverage must 
include a statement, in any plan materials provided to a participant or 
beneficiary describing the benefits provided under the plan or health 
insurance coverage, that the plan or coverage believes it is a 
grandfathered health plan within the meaning of section 1251 of the 
Patient Protection and Affordable Care Act and must provide contact 
information for questions and complaints.
    (ii) The following model language can be used to satisfy this 
disclosure requirement:

    This [group health plan or health insurance issuer] believes this 
[plan or coverage] is a ``grandfathered health plan'' under the Patient 
Protection and Affordable Care Act (the Affordable Care Act). As 
permitted by the Affordable Care Act, a grandfathered health plan can 
preserve certain basic health coverage that was already in effect when 
that law was enacted. Being a grandfathered health plan means that your 
[plan or policy] may not include certain consumer protections of the 
Affordable Care Act that apply to other plans, for example, the 
requirement for the provision of preventive health services without any 
cost sharing. However, grandfathered health plans must comply with 
certain other consumer protections in the Affordable Care Act, for 
example, the elimination of lifetime limits on benefits.
    Questions regarding which protections apply and which protections do 
not apply to a grandfathered health plan and what might cause a plan to 
change from grandfathered health plan status can be directed to the plan 
administrator at [insert contact information]. [For ERISA plans, insert: 
You may also contact the Employee Benefits Security Administration, U.S. 
Department of Labor at 1-866-444-3272 or www.dol.gov/ebsa/healthreform. 
This website has a table summarizing which protections do and do not 
apply to grandfathered health plans.] [For individual market policies 
and nonfederal governmental plans, insert: You may also contact the U.S. 
Department of Health and Human Services at www.healthreform.gov.]

    (3)(i) Documentation of plan or policy terms on March 23, 2010. To 
maintain status as a grandfathered health plan, a group health plan, or 
group health insurance coverage, must, for as long as the plan or health 
insurance coverage takes the position that it is a grandfathered health 
plan--
    (A) Maintain records documenting the terms of the plan or health 
insurance coverage in connection with the coverage in effect on March 
23, 2010, and any other documents necessary to verify, explain, or 
clarify its status as a grandfathered health plan; and
    (B) Make such records available for examination upon request.
    (ii) Change in group health insurance coverage. To maintain status 
as a grandfathered health plan, a group health plan that enters into a 
new policy, certificate, or contract of insurance must provide to the 
new health insurance issuer (and the new health insurance issuer must 
require) documentation of plan terms (including benefits, cost sharing, 
employer contributions, and annual limits) under the prior health 
coverage sufficient to determine whether a change causing a cessation of 
grandfathered health plan status under paragraph (g)(1) of this section 
has occurred.
    (4) Family members enrolling after March 23, 2010. With respect to 
an individual who is enrolled in a group health plan or health insurance 
coverage on March 23, 2010, grandfathered health plan coverage includes 
coverage of family members of the individual who enroll after March 23, 
2010 in the grandfathered health plan coverage of the individual.
    (b) Allowance for new employees to join current plan--(1) In 
general. Subject to paragraph (b)(2) of this section, a group health 
plan (including health insurance coverage provided in connection with 
the group health plan) that provided coverage on March 23, 2010 and has 
retained its status as a grandfathered health plan (consistent with the 
rules of this section, including paragraph (g) of this section) is 
grandfathered health plan coverage for new employees (whether newly 
hired or newly enrolled) and their families enrolling in the plan after 
March 23, 2010.

[[Page 473]]

    (2) Anti-abuse rules--(i) Mergers and acquisitions. If the principal 
purpose of a merger, acquisition, or similar business restructuring is 
to cover new individuals under a grandfathered health plan, the plan 
ceases to be a grandfathered health plan.
    (ii) Change in plan eligibility. A group health plan or health 
insurance coverage (including a benefit package under a group health 
plan) ceases to be a grandfathered health plan if--
    (A) Employees are transferred into the plan or health insurance 
coverage (the transferee plan) from a plan or health insurance coverage 
under which the employees were covered on March 23, 2010 (the transferor 
plan);
    (B) Comparing the terms of the transferee plan with those of the 
transferor plan (as in effect on March 23, 2010) and treating the 
transferee plan as if it were an amendment of the transferor plan would 
cause a loss of grandfather status under the provisions of paragraph 
(g)(1) of this section; and
    (C) There was no bona fide employment-based reason to transfer the 
employees into the transferee plan. For this purpose, changing the terms 
or cost of coverage is not a bona fide employment-based reason.
    (3) Examples. The rules of this paragraph (b) are illustrated by the 
following examples:

    Example 1. (i) Facts. A group health plan offers two benefit 
packages on March 23, 2010, Options F and G. During a subsequent open 
enrollment period, some of the employees enrolled in Option F on March 
23, 2010 switch to Option G.
    (ii) Conclusion. In this Example 1, the group health coverage 
provided under Option G remains a grandfathered health plan under the 
rules of paragraph (b)(1) of this section because employees previously 
enrolled in Option F are allowed to enroll in Option G as new employees.
    Example 2. (i) Facts. Same facts as Example 1, except that the plan 
sponsor eliminates Option F because of its high cost and transfers 
employees covered under Option F to Option G. If instead of transferring 
employees from Option F to Option G, Option F was amended to match the 
terms of Option G, then Option F would cease to be a grandfathered 
health plan.
    (ii) Conclusion. In this Example 2, the plan did not have a bona 
fide employment-based reason to transfer employees from Option F to 
Option G. Therefore, Option G ceases to be a grandfathered health plan 
with respect to all employees. (However, any other benefit package 
maintained by the plan sponsor is analyzed separately under the rules of 
this section.)
    Example 3. (i) Facts. A group health plan offers two benefit 
packages on March 23, 2010, Options H and I. On March 23, 2010, Option H 
provides coverage only for employees in one manufacturing plant. 
Subsequently, the plant is closed, and some employees in the closed 
plant are moved to another plant. The employer eliminates Option H and 
the employees that are moved are transferred to Option I. If instead of 
transferring employees from Option H to Option I, Option H was amended 
to match the terms of Option I, then Option H would cease to be a 
grandfathered health plan.
    (ii) Conclusion. In this Example 3, the plan has a bona fide 
employment-based reason to transfer employees from Option H to Option I. 
Therefore, Option I does not cease to be a grandfathered health plan.

    (c) General grandfathering rule--(1) Except as provided in 
paragraphs (d) and (e) of this section, subtitles A and C of title I of 
the Patient Protection and Affordable Care Act (and the amendments made 
by those subtitles, and the incorporation of those amendments into 
section 9815 and ERISA section 715) do not apply to grandfathered health 
plan coverage. Accordingly, the provisions of PHS Act sections 2701, 
2702, 2703, 2705, 2706, 2707, 2709 (relating to coverage for individuals 
participating in approved clinical trials, as added by section 10103 of 
the Patient Protection and Affordable Care Act), 2713, 2715A, 2716, 
2717, 2719, and 2719A, as added or amended by the Patient Protection and 
Affordable Care Act, do not apply to grandfathered health plans. (In 
addition, see 45 CFR 147.140(c), which provides that the provisions of 
PHS Act section 2704, and PHS Act section 2711 insofar as it relates to 
annual limits, do not apply to grandfathered health plans that are 
individual health insurance coverage.)
    (2) To the extent not inconsistent with the rules applicable to a 
grandfathered health plan, a grandfathered health plan must comply with 
the requirements of the Code, the PHS Act, and ERISA applicable prior to 
the changes enacted by the Patient Protection and Affordable Care Act.
    (d) Provisions applicable to all grandfathered health plans. The 
provisions of

[[Page 474]]

PHS Act section 2711 insofar as it relates to lifetime limits, and the 
provisions of PHS Act sections 2712, 2714, 2715, and 2718, apply to 
grandfathered health plans for plan years beginning on or after 
September 23, 2010. The provisions of PHS Act section 2708 apply to 
grandfathered health plans for plan years beginning on or after January 
1, 2014.
    (e) Applicability of PHS Act sections 2704, 2711, and 2714 to 
grandfathered group health plans and group health insurance coverage--
(1) The provisions of PHS Act section 2704 as it applies with respect to 
enrollees who are under 19 years of age, and the provisions of PHS Act 
section 2711 insofar as it relates to annual limits, apply to 
grandfathered health plans that are group health plans (including group 
health insurance coverage) for plan years beginning on or after 
September 23, 2010. The provisions of PHS Act section 2704 apply 
generally to grandfathered health plans that are group health plans 
(including group health insurance coverage) for plan years beginning on 
or after January 1, 2014.
    (2) For plan years beginning before January 1, 2014, the provisions 
of PHS Act section 2714 apply in the case of an adult child with respect 
to a grandfathered health plan that is a group health plan only if the 
adult child is not eligible to enroll in an eligible employer-sponsored 
health plan (as defined in section 5000A(f)(2)) other than a 
grandfathered health plan of a parent. For plan years beginning on or 
after January 1, 2014, the provisions of PHS Act section 2714 apply with 
respect to a grandfathered health plan that is a group health plan 
without regard to whether an adult child is eligible to enroll in any 
other coverage.
    (f) Effect on collectively bargained plans--In general. In the case 
of health insurance coverage maintained pursuant to one or more 
collective bargaining agreements between employee representatives and 
one or more employers that was ratified before March 23, 2010, the 
coverage is grandfathered health plan coverage at least until the date 
on which the last of the collective bargaining agreements relating to 
the coverage that was in effect on March 23, 2010 terminates. Any 
coverage amendment made pursuant to a collective bargaining agreement 
relating to the coverage that amends the coverage solely to conform to 
any requirement added by subtitles A and C of title I of the Patient 
Protection and Affordable Care Act (and the amendments made by those 
subtitles, and the incorporation of those amendments into section 9815 
and ERISA section 715) is not treated as a termination of the collective 
bargaining agreement. After the date on which the last of the collective 
bargaining agreements relating to the coverage that was in effect on 
March 23, 2010 terminates, the determination of whether health insurance 
coverage maintained pursuant to a collective bargaining agreement is 
grandfathered health plan coverage is made under the rules of this 
section other than this paragraph (f) (comparing the terms of the health 
insurance coverage after the date the last collective bargaining 
agreement terminates with the terms of the health insurance coverage 
that were in effect on March 23, 2010).
    (g) Maintenance of grandfather status--(1) Changes causing cessation 
of grandfather status. Subject to paragraph (g)(2) of this section, the 
rules of this paragraph (g)(1) describe situations in which a group 
health plan or health insurance coverage ceases to be a grandfathered 
health plan.
    (i) Elimination of benefits. The elimination of all or substantially 
all benefits to diagnose or treat a particular condition causes a group 
health plan or health insurance coverage to cease to be a grandfathered 
health plan. For this purpose, the elimination of benefits for any 
necessary element to diagnose or treat a condition is considered the 
elimination of all or substantially all benefits to diagnose or treat a 
particular condition.
    (ii) Increase in percentage cost-sharing requirement. Any increase, 
measured from March 23, 2010, in a percentage cost-sharing requirement 
(such as an individual's coinsurance requirement) causes a group health 
plan or health insurance coverage to cease to be a grandfathered health 
plan.
    (iii) Increase in a fixed-amount cost-sharing requirement other than 
a copayment. Any increase in a fixed-amount cost-sharing requirement 
other than a

[[Page 475]]

copayment (for example, deductible or out-of-pocket limit), determined 
as of the effective date of the increase, causes a group health plan or 
health insurance coverage to cease to be a grandfathered health plan, if 
the total percentage increase in the cost-sharing requirement measured 
from March 23, 2010 exceeds the maximum percentage increase (as defined 
in paragraph (g)(3)(ii) of this section).
    (iv) Increase in a fixed-amount copayment. Any increase in a fixed-
amount copayment, determined as of the effective date of the increase, 
causes a group health plan or health insurance coverage to cease to be a 
grandfathered health plan, if the total increase in the copayment 
measured from March 23, 2010 exceeds the greater of:
    (A) An amount equal to $5 increased by medical inflation, as defined 
in paragraph (g)(3)(i) of this section (that is, $5 times medical 
inflation, plus $5), or
    (B) The maximum percentage increase (as defined in paragraph 
(g)(3)(ii) of this section), determined by expressing the total increase 
in the copayment as a percentage.
    (v) Decrease in contribution rate by employers and employee 
organizations--(A) Contribution rate based on cost of coverage. A group 
health plan or group health insurance coverage ceases to be a 
grandfathered health plan if the employer or employee organization 
decreases its contribution rate based on cost of coverage (as defined in 
paragraph (g)(3)(iii)(A) of this section) towards the cost of any tier 
of coverage for any class of similarly situated individuals (as 
described in Sec. 54.9802-1(d)) by more than 5 percentage points below 
the contribution rate for the coverage period that includes March 23, 
2010.
    (B) Contribution rate based on a formula. A group health plan or 
group health insurance coverage ceases to be a grandfathered health plan 
if the employer or employee organization decreases its contribution rate 
based on a formula (as defined in paragraph (g)(3)(iii)(B) of this 
section) towards the cost of any tier of coverage for any class of 
similarly situated individuals (as described in Sec. 54.9802-1(d)) by 
more than 5 percent below the contribution rate for the coverage period 
that includes March 23, 2010.
    (vi) Changes in annual limits--(A) Addition of an annual limit. A 
group health plan, or group health insurance coverage, that, on March 
23, 2010, did not impose an overall annual or lifetime limit on the 
dollar value of all benefits ceases to be a grandfathered health plan if 
the plan or health insurance coverage imposes an overall annual limit on 
the dollar value of benefits.
    (B) Decrease in limit for a plan or coverage with only a lifetime 
limit. A group health plan, or group health insurance coverage, that, on 
March 23, 2010, imposed an overall lifetime limit on the dollar value of 
all benefits but no overall annual limit on the dollar value of all 
benefits ceases to be a grandfathered health plan if the plan or health 
insurance coverage adopts an overall annual limit at a dollar value that 
is lower than the dollar value of the lifetime limit on March 23, 2010.
    (C) Decrease in limit for a plan or coverage with an annual limit. A 
group health plan, or group health insurance coverage, that, on March 
23, 2010, imposed an overall annual limit on the dollar value of all 
benefits ceases to be a grandfathered health plan if the plan or health 
insurance coverage decreases the dollar value of the annual limit 
(regardless of whether the plan or health insurance coverage also 
imposed an overall lifetime limit on March 23, 2010 on the dollar value 
of all benefits).
    (2) Transitional rules--(i) Changes made prior to March 23, 2010. If 
a group health plan or health insurance issuer makes the following 
changes to the terms of the plan or health insurance coverage, the 
changes are considered part of the terms of the plan or health insurance 
coverage on March 23, 2010 even though they were not effective at that 
time and such changes do not cause a plan or health insurance coverage 
to cease to be a grandfathered health plan:
    (A) Changes effective after March 23, 2010 pursuant to a legally 
binding contract entered into on or before March 23, 2010;
    (B) Changes effective after March 23, 2010 pursuant to a filing on 
or before March 23, 2010 with a State insurance department; or

[[Page 476]]

    (C) Changes effective after March 23, 2010 pursuant to written 
amendments to a plan that were adopted on or before March 23, 2010.
    (ii) Changes made after March 23, 2010 and adopted prior to issuance 
of regulations. If, after March 23, 2010, a group health plan or health 
insurance issuer makes changes to the terms of the plan or health 
insurance coverage and the changes are adopted prior to June 14, 2010, 
the changes will not cause the plan or health insurance coverage to 
cease to be a grandfathered health plan if the changes are revoked or 
modified effective as of the first day of the first plan year (in the 
individual market, policy year) beginning on or after September 23, 
2010, and the terms of the plan or health insurance coverage on that 
date, as modified, would not cause the plan or coverage to cease to be a 
grandfathered health plan under the rules of this section, including 
paragraph (g)(1) of this section. For this purpose, changes will be 
considered to have been adopted prior to June 14, 2010 if:
    (A) The changes are effective before that date;
    (B) The changes are effective on or after that date pursuant to a 
legally binding contract entered into before that date;
    (C) The changes are effective on or after that date pursuant to a 
filing before that date with a State insurance department; or
    (D) The changes are effective on or after that date pursuant to 
written amendments to a plan that were adopted before that date.
    (3) Definitions--(i) Medical inflation defined. For purposes of this 
paragraph (g), the term medical inflation means the increase since March 
2010 in the overall medical care component of the Consumer Price Index 
for All Urban Consumers (CPI-U) (unadjusted) published by the Department 
of Labor using the 1982-1984 base of 100. For this purpose, the increase 
in the overall medical care component is computed by subtracting 387.142 
(the overall medical care component of the CPI-U (unadjusted) published 
by the Department of Labor for March 2010, using the 1982-1984 base of 
100) from the index amount for any month in the 12 months before the new 
change is to take effect and then dividing that amount by 387.142.
    (ii) Maximum percentage increase defined. For purposes of this 
paragraph (g), the term maximum percentage increase means medical 
inflation (as defined in paragraph (g)(3)(i) of this section), expressed 
as a percentage, plus 15 percentage points.
    (iii) Contribution rate defined. For purposes of paragraph (g)(1)(v) 
of this section:
    (A) Contribution rate based on cost of coverage. The term 
contribution rate based on cost of coverage means the amount of 
contributions made by an employer or employee organization compared to 
the total cost of coverage, expressed as a percentage. The total cost of 
coverage is determined in the same manner as the applicable premium is 
calculated under the COBRA continuation provisions of section 
4980B(f)(4), section 604 of ERISA, and section 2204 of the PHS Act. In 
the case of a self-insured plan, contributions by an employer or 
employee organization are equal to the total cost of coverage minus the 
employee contributions towards the total cost of coverage.
    (B) Contribution rate based on a formula. The term contribution rate 
based on a formula means, for plans that, on March 23, 2010, made 
contributions based on a formula (such as hours worked or tons of coal 
mined), the formula.
    (4) Examples. The rules of this paragraph (g) are illustrated by the 
following examples:

    Example 1. (i) Facts. On March 23, 2010, a grandfathered health plan 
has a coinsurance requirement of 20% for inpatient surgery. The plan is 
subsequently amended to increase the coinsurance requirement to 25%.
    (ii) Conclusion. In this Example 1, the increase in the coinsurance 
requirement from 20% to 25% causes the plan to cease to be a 
grandfathered health plan.
    Example 2. (i) Facts. Before March 23, 2010, the terms of a group 
health plan provide benefits for a particular mental health condition, 
the treatment for which is a combination of counseling and prescription 
drugs. Subsequently, the plan eliminates benefits for counseling.
    (ii) Conclusion. In this Example 2, the plan ceases to be a 
grandfathered health plan because counseling is an element that is 
necessary to treat the condition. Thus the plan

[[Page 477]]

is considered to have eliminated substantially all benefits for the 
treatment of the condition.
    Example 3. (i) Facts. On March 23, 2010, a grandfathered health plan 
has a copayment requirement of $30 per office visit for specialists. The 
plan is subsequently amended to increase the copayment requirement to 
$40. Within the 12-month period before the $40 copayment takes effect, 
the greatest value of the overall medical care component of the CPI-U 
(unadjusted) is 475.
    (ii) Conclusion. In this Example 3, the increase in the copayment 
from $30 to $40, expressed as a percentage, is 33.33% (40 - 30 = 10; 10 
/ 30 = 0.3333; 0.3333 = 33.33%). Medical inflation (as defined in 
paragraph (g)(3)(i) of this section) from March 2010 is 0.2269 (475 - 
387.142 = 87.858; 87.858 / 387.142 = 0.2269). The maximum percentage 
increase permitted is 37.69% (0.2269 = 22.69%; 22.69% + 15% = 37.69%). 
Because 33.33% does not exceed 37.69%, the change in the copayment 
requirement at that time does not cause the plan to cease to be a 
grandfathered health plan.
    Example 4. (i) Facts. Same facts as Example 3, except the 
grandfathered health plan subsequently increases the $40 copayment 
requirement to $45 for a later plan year. Within the 12-month period 
before the $45 copayment takes effect, the greatest value of the overall 
medical care component of the CPI-U (unadjusted) is 485.
    (ii) Conclusion. In this Example 4, the increase in the copayment 
from $30 (the copayment that was in effect on March 23, 2010) to $45, 
expressed as a percentage, is 50% (45 - 30 = 15; 15 / 30 = 0.5; 0.5 = 
50%). Medical inflation (as defined in paragraph (g)(3)(i) of this 
section) from March 2010 is 0.2527 (485 - 387.142 = 97.858; 97.858 / 
387.142 = 0.2527). The increase that would cause a plan to cease to be a 
grandfathered health plan under paragraph (g)(1)(iv) of this section is 
the greater of the maximum percentage increase of 40.27% (0.2527 = 
25.27%; 25.27% + 15% = 40.27%), or $6.26 ($5 x 0.2527 = $1.26; $1.26 + 
$5 = $6.26). Because 50% exceeds 40.27% and $15 exceeds $6.26, the 
change in the copayment requirement at that time causes the plan to 
cease to be a grandfathered health plan.
    Example 5. (i) Facts. On March 23, 2010, a grandfathered health plan 
has a copayment of $10 per office visit for primary care providers. The 
plan is subsequently amended to increase the copayment requirement to 
$15. Within the 12-month period before the $15 copayment takes effect, 
the greatest value of the overall medical care component of the CPI-U 
(unadjusted) is 415.
    (ii) Conclusion. In this Example 5, the increase in the copayment, 
expressed as a percentage, is 50% (15 - 10 = 5; 5 / 10 = 0.5; 0.5 = 
50%). Medical inflation (as defined in paragraph (g)(3) of this section) 
from March 2010 is 0.0720 (415.0 - 387.142 = 27.858; 27.858 / 387.142 = 
0.0720). The increase that would cause a plan to cease to be a 
grandfathered health plan under paragraph (g)(1)(iv) of this section is 
the greater of the maximum percentage increase of 22.20% (0.0720 = 
7.20%; 7.20% + 15% = 22.20), or $5.36 ($5 x 0.0720 = $0.36; $0.36 + $5 = 
$5.36). The $5 increase in copayment in this Example 5 would not cause 
the plan to cease to be a grandfathered health plan pursuant to 
paragraph (g)(1)(iv) of this section, which would permit an increase in 
the copayment of up to $5.36.
    Example 6. (i) Facts. The same facts as Example 5, except on March 
23, 2010, the grandfathered health plan has no copayment ($0) for office 
visits for primary care providers. The plan is subsequently amended to 
increase the copayment requirement to $5.
    (ii) Conclusion. In this Example 6, medical inflation (as defined in 
paragraph (g)(3)(i) of this section) from March 2010 is 0.0720 (415.0 - 
387.142 = 27.858; 27.858 / 387.142 = 0.0720). The increase that would 
cause a plan to cease to be a grandfathered health plan under paragraph 
(g)(1)(iv)(A) of this section is $5.36 ($5 x 0.0720 = $0.36; $0.36 + $5 
= $5.36). The $5 increase in copayment in this Example 6 is less than 
the amount calculated pursuant to paragraph (g)(1)(iv)(A) of this 
section of $5.36. Thus, the $5 increase in copayment does not cause the 
plan to cease to be a grandfathered health plan.
    Example 7. (i) Facts. On March 23, 2010, a self-insured group health 
plan provides two tiers of coverage--self-only and family. The employer 
contributes 80% of the total cost of coverage for self-only and 60% of 
the total cost of coverage for family. Subsequently, the employer 
reduces the contribution to 50% for family coverage, but keeps the same 
contribution rate for self-only coverage.
    (ii) Conclusion. In this Example 7, the decrease of 10 percentage 
points for family coverage in the contribution rate based on cost of 
coverage causes the plan to cease to be a grandfathered health plan. The 
fact that the contribution rate for self-only coverage remains the same 
does not change the result.
    Example 8. (i) Facts. On March 23, 2010, a self-insured 
grandfathered health plan has a COBRA premium for the 2010 plan year of 
$5000 for self-only coverage and $12,000 for family coverage. The 
required employee contribution for the coverage is $1000 for self-only 
coverage and $4000 for family coverage. Thus, the contribution rate 
based on cost of coverage for 2010 is 80% ((5000 - 1000)/5000) for self-
only coverage and 67% ((12,000 - 4000)/12,000) for family coverage. For 
a subsequent plan year, the COBRA premium is $6000 for self-only 
coverage and $15,000 for family coverage. The employee contributions for 
that plan year are $1200 for self-only coverage and $5000 for family 
coverage. Thus, the contribution rate based on cost of coverage is 80% 
((6000 - 1200)/6000) for self-only coverage and 67% ((15,000 - 5000)/
15,000) for family coverage.

[[Page 478]]

    (ii) Conclusion. In this Example 8, because there is no change in 
the contribution rate based on cost of coverage, the plan retains its 
status as a grandfathered health plan. The result would be the same if 
all or part of the employee contribution was made pre-tax through a 
cafeteria plan under section 125 of the Internal Revenue Code.
    Example 9. (i) Facts. A group health plan not maintained pursuant to 
a collective bargaining agreement offers three benefit packages on March 
23, 2010. Option F is a self-insured option. Options G and H are insured 
options. Beginning July 1, 2013, the plan increases coinsurance under 
Option H from 10% to 15%.
    (ii) Conclusion. In this Example 9, the coverage under Option H is 
not grandfathered health plan coverage as of July 1, 2013, consistent 
with the rule in paragraph (g)(1)(ii) of this section. Whether the 
coverage under Options F and G is grandfathered health plan coverage is 
determined separately under the rules of this paragraph (g).

    (h) Expiration date. This section expires on or before June 14, 
2013.

[T.D. 9489, 75 FR 34558, June 17, 2010, as amended by T.D. 9506, 75 FR 
70120, Nov. 17, 2010]



Sec. 54.9815-2704T  Prohibition of preexisting condition exclusions
(temporary).

    (a) No preexisting condition exclusions--(1) In general. A group 
health plan, or a health insurance issuer offering group health 
insurance coverage, may not impose any preexisting condition exclusion 
(as defined in Sec. 54.9801-2).
    (2) Examples. The rules of this paragraph (a) are illustrated by the 
following examples (for additional examples illustrating the definition 
of a preexisting condition exclusion, see Sec. 54.9801-3(a)(1)(ii)):

    Example 1. (i) Facts. A group health plan provides benefits solely 
through an insurance policy offered by Issuer P. At the expiration of 
the policy, the plan switches coverage to a policy offered by Issuer N. 
N's policy excludes benefits for oral surgery required as a result of a 
traumatic injury if the injury occurred before the effective date of 
coverage under the policy.
    (ii) Conclusion. In this Example 1, the exclusion of benefits for 
oral surgery required as a result of a traumatic injury if the injury 
occurred before the effective date of coverage is a preexisting 
condition exclusion because it operates to exclude benefits for a 
condition based on the fact that the condition was present before the 
effective date of coverage under the policy.
    Example 2. (i) Facts. Individual C applies for individual health 
insurance coverage with Issuer M. M denies C's application for coverage 
because a pre-enrollment physical revealed that C has type 2 diabetes.
    (ii) Conclusion. See Example 2 in 45 CFR 147.108(a)(2) for a 
conclusion that M's denial of C's application for coverage is a 
preexisting condition exclusion because a denial of an application for 
coverage based on the fact that a condition was present before the date 
of denial is an exclusion of benefits based on a preexisting condition.

    (b) Effective/applicability date--(1) General applicability date. 
Except as provided in paragraph (b)(2) of this section, the rules of 
this section apply for plan years beginning on or after January 1, 2014.
    (2) Early applicability date for children. The rules of this section 
apply with respect to enrollees, including applicants for enrollment, 
who are under 19 years of age for plan years beginning on or after 
September 23, 2010.
    (3) Applicability to grandfathered health plans. See Sec. 54.9815-
1251T for determining the application of this section to grandfathered 
health plans (providing that a grandfathered health plan that is a group 
health plan or group health insurance coverage must comply with the 
prohibition against preexisting condition exclusions).
    (4) Example. The rules of this paragraph (b) are illustrated by the 
following example:

    Example. (i) Facts. Individual F commences employment and enrolls F 
and F's 16-year-old child in the group health plan maintained by F's 
employer, with a first day of coverage of October 15, 2010. F's child 
had a significant break in coverage because of a lapse of more than 63 
days without creditable coverage immediately prior to enrolling in the 
plan. F's child was treated for asthma within the six-month period prior 
to the enrollment date and the plan imposes a 12-month preexisting 
condition exclusion for coverage of asthma. The next plan year begins on 
January 1, 2011.
    (ii) Conclusion. In this Example, the plan year beginning January 1, 
2011 is the first plan year of the group health plan beginning on or 
after September 23, 2010. Thus, beginning on January 1, 2011, because 
the child is under 19 years of age, the plan cannot impose a preexisting 
condition exclusion with respect to the child's asthma regardless of the 
fact that the preexisting condition exclusion was imposed by the plan 
before the applicability date of this provision.


[[Page 479]]


    (c) Expiration date. This section expires on June 21, 2013.

[T.D. 9491, 75 FR 37223, June 28, 2010]



Sec. 54.9815-2711T  No lifetime or annual limits (temporary).

    (a) Prohibition--(1) Lifetime limits. Except as provided in 
paragraph (b) of this section, a group health plan, or a health 
insurance issuer offering group health insurance coverage, may not 
establish any lifetime limit on the dollar amount of benefits for any 
individual.
    (2) Annual limits--(i) General rule. Except as provided in 
paragraphs (a)(2)(ii), (b), and (d) of this section, a group health 
plan, or a health insurance issuer offering group health insurance 
coverage, may not establish any annual limit on the dollar amount of 
benefits for any individual.
    (ii) Exception for health flexible spending arrangements. A health 
flexible spending arrangement (as defined in section 106(c)(2)) is not 
subject to the requirement in paragraph (a)(2)(i) of this section.
    (b) Construction--(1) Permissible limits on specific covered 
benefits. The rules of this section do not prevent a group health plan, 
or a health insurance issuer offering group health insurance coverage, 
from placing annual or lifetime dollar limits with respect to any 
individual on specific covered benefits that are not essential health 
benefits to the extent that such limits are otherwise permitted under 
applicable Federal or State law. (The scope of essential health benefits 
is addressed in paragraph (c) of this section.)
    (2) Condition-based exclusions. The rules of this section do not 
prevent a group health plan, or a health insurance issuer offering group 
health insurance coverage, from excluding all benefits for a condition. 
However, if any benefits are provided for a condition, then the 
requirements of this section apply. Other requirements of Federal or 
State law may require coverage of certain benefits.
    (c) Definition of essential health benefits. The term ``essential 
health benefits'' means essential health benefits under section 1302(b) 
of the Patient Protection and Affordable Care Act and applicable 
regulations.
    (d) Restricted annual limits permissible prior to 2014--(1) In 
general. With respect to plan years beginning prior to January 1, 2014, 
a group health plan, or a health insurance issuer offering group health 
insurance coverage, may establish, for any individual, an annual limit 
on the dollar amount of benefits that are essential health benefits, 
provided the limit is no less than the amounts in the following 
schedule:
    (i) For a plan year beginning on or after September 23, 2010, but 
before September 23, 2011, $750,000.
    (ii) For a plan year beginning on or after September 23, 2011, but 
before September 23, 2012, $1,250,000.
    (iii) For plan years beginning on or after September 23, 2012, but 
before January 1, 2014, $2,000,000.
    (2) Only essential health benefits taken into account. In 
determining whether an individual has received benefits that meet or 
exceed the applicable amount described in paragraph (d)(1) of this 
section, a plan or issuer must take into account only essential health 
benefits.
    (3) Waiver authority of the Secretary of Health and Human Services. 
For plan years beginning before January 1, 2014, the Secretary of Health 
and Human Services may establish a program under which the requirements 
of paragraph (d)(1) of this section relating to annual limits may be 
waived (for such period as is specified by the Secretary of Health and 
Human Services) for a group health plan or health insurance coverage 
that has an annual dollar limit on benefits below the restricted annual 
limits provided under paragraph (d)(1) of this section if compliance 
with paragraph (d)(1) of this section would result in a significant 
decrease in access to benefits under the plan or health insurance 
coverage or would significantly increase premiums for the plan or health 
insurance coverage.
    (e) Transitional rules for individuals whose coverage or benefits 
ended by reason of reaching a lifetime limit--(1) In general. The relief 
provided in the transitional rules of this paragraph (e) applies with 
respect to any individual--
    (i) Whose coverage or benefits under a group health plan or group 
health insurance coverage ended by reason of reaching a lifetime limit 
on the dollar

[[Page 480]]

value of all benefits for any individual (which, under this section, is 
no longer permissible); and
    (ii) Who becomes eligible (or is required to become eligible) for 
benefits not subject to a lifetime limit on the dollar value of all 
benefits under the group health plan or group health insurance coverage 
on the first day of the first plan year beginning on or after September 
23, 2010, by reason of the application of this section.
    (2) Notice and enrollment opportunity requirements--(i) If an 
individual described in paragraph (e)(1) of this section is eligible for 
benefits (or is required to become eligible for benefits) under the 
group health plan--or group health insurance coverage--described in 
paragraph (e)(1) of this section, the plan and the issuer are required 
to give the individual written notice that the lifetime limit on the 
dollar value of all benefits no longer applies and that the individual, 
if covered, is once again eligible for benefits under the plan. 
Additionally, if the individual is not enrolled in the plan or health 
insurance coverage, or if an enrolled individual is eligible for but not 
enrolled in any benefit package under the plan or health insurance 
coverage, then the plan and issuer must also give such an individual an 
opportunity to enroll that continues for at least 30 days (including 
written notice of the opportunity to enroll). The notices and enrollment 
opportunity required under this paragraph (e)(2)(i) must be provided 
beginning not later than the first day of the first plan year beginning 
on or after September 23, 2010.
    (ii) The notices required under paragraph (e)(2)(i) of this section 
may be provided to an employee on behalf of the employee's dependent. In 
addition, the notices may be included with other enrollment materials 
that a plan distributes to employees, provided the statement is 
prominent. For either notice, if a notice satisfying the requirements of 
this paragraph (e)(2) is provided to an individual, the obligation to 
provide the notice with respect to that individual is satisfied for both 
the plan and the issuer.
    (3) Effective date of coverage. In the case of an individual who 
enrolls under paragraph (e)(2) of this section, coverage must take 
effect not later than the first day of the first plan year beginning on 
or after September 23, 2010.
    (4) Treatment of enrollees in a group health plan. Any individual 
enrolling in a group health plan pursuant to paragraph (e)(2) of this 
section must be treated as if the individual were a special enrollee, as 
provided under the rules of Sec. 54.9801-6(d). Accordingly, the 
individual (and, if the individual would not be a participant once 
enrolled in the plan, the participant through whom the individual is 
otherwise eligible for coverage under the plan) must be offered all the 
benefit packages available to similarly situated individuals who did not 
lose coverage by reason of reaching a lifetime limit on the dollar value 
of all benefits. For this purpose, any difference in benefits or cost-
sharing requirements constitutes a different benefit package. The 
individual also cannot be required to pay more for coverage than 
similarly situated individuals who did not lose coverage by reason of 
reaching a lifetime limit on the dollar value of all benefits.
    (5) Examples. The rules of this paragraph (e) are illustrated by the 
following examples:

    Example 1. (i) Facts. Employer Y maintains a group health plan with 
a calendar year plan year. The plan has a single benefit package. For 
plan years beginning before September 23, 2010, the plan has a lifetime 
limit on the dollar value of all benefits. Individual B, an employee of 
Y, was enrolled in Y's group health plan at the beginning of the 2008 
plan year. On June 10, 2008, B incurred a claim for benefits that 
exceeded the lifetime limit under Y's plan and ceased to be enrolled in 
the plan. B is still eligible for coverage under Y's group health plan. 
On or before January 1, 2011, Y's group health plan gives B written 
notice informing B that the lifetime limit on the dollar value of all 
benefits no longer applies, that individuals whose coverage ended by 
reason of reaching a lifetime limit under the plan are eligible to 
enroll in the plan, and that individuals can request such enrollment 
through February 1, 2011 with enrollment effective retroactively to 
January 1, 2011.
    (ii) Conclusion. In this Example 1, the plan has complied with the 
requirements of this paragraph (e) by providing a timely written notice 
and enrollment opportunity to B that lasts at least 30 days.
    Example 2. (i) Facts. Employer Z maintains a group health plan with 
a plan year beginning October 1 and ending September 30.

[[Page 481]]

Prior to October 1, 2010, the group health plan has a lifetime limit on 
the dollar value of all benefits. Individual D, an employee of Z, and 
Individual E, D's child, were enrolled in family coverage under Z's 
group health plan for the plan year beginning on October 1, 2008. On May 
1, 2009, E incurred a claim for benefits that exceeded the lifetime 
limit under Z's plan. D dropped family coverage but remains an employee 
of Z and is still eligible for coverage under Z's group health plan.
    (ii) Conclusion. In this Example 2, not later than October 1, 2010, 
the plan must provide D and E an opportunity to enroll (including 
written notice of an opportunity to enroll) that continues for at least 
30 days, with enrollment effective not later than October 1, 2010.
    Example 3. (i) Facts. Same facts as Example 2, except that Z's plan 
had two benefit packages (a low-cost and a high-cost option). Instead of 
dropping coverage, D switched to the low-cost benefit package option.
    (ii) Conclusion. In this Example 3, not later than October 1, 2010, 
the plan must provide D and E an opportunity to enroll in any benefit 
package available to similarly situated individuals who enroll when 
first eligible. The plan would have to provide D and E the opportunity 
to enroll in any benefit package available to similarly situated 
individuals who enroll when first eligible, even if D had not switched 
to the low-cost benefit package option.
    Example 4. (i) Facts. Employer Q maintains a group health plan with 
a plan year beginning October 1 and ending September 30. For the plan 
year beginning on October 1, 2009, Q has an annual limit on the dollar 
value of all benefits of $500,000.
    (ii) Conclusion. In this Example 4, Q must raise the annual limit on 
the dollar value of essential health benefits to at least $750,000 for 
the plan year beginning October 1, 2010. For the plan year beginning 
October 1, 2011, Q must raise the annual limit to at least $1.25 
million. For the plan year beginning October 1, 2012, Q must raise the 
annual limit to at least $2 million. Q may also impose a restricted 
annual limit of $2 million for the plan year beginning October 1, 2013. 
After the conclusion of that plan year, Q cannot impose an overall 
annual limit.
    Example 5. (i) Facts. Same facts as Example 4, except that the 
annual limit for the plan year beginning on October 1, 2009 is $1 
million and Q lowers the annual limit for the plan year beginning 
October 1, 2010 to $750,000.
    (ii) Conclusion. In this Example 5, Q complies with the requirements 
of this paragraph (e). However, Q's choice to lower its annual limit 
means that under Sec. 54.9815-1251T(g)(1)(vi)(C), the group health plan 
will cease to be a grandfathered health plan and will be generally 
subject to all of the provisions of PHS Act sections 2701 through 2719A.

    (f) Effective/applicability date. The provisions of this section 
apply for plan years beginning on or after September 23, 2010. See Sec. 
54.9815-1251T for determining the application of this section to 
grandfathered health plans (providing that the prohibitions on lifetime 
and annual limits apply to all grandfathered health plans that are group 
health plans and group health insurance coverage, including the special 
rules regarding restricted annual limits).
    (g) Expiration date. This section expires on June 21, 2013.

[T.D. 9491, 75 FR 37223, June 28, 2010]



Sec. 54.9815-2712T  Rules regarding rescissions (temporary).

    (a) Prohibition on rescissions--(1) A group health plan, or a health 
insurance issuer offering group health insurance coverage, must not 
rescind coverage under the plan, or under the policy, certificate, or 
contract of insurance, with respect to an individual (including a group 
to which the individual belongs or family coverage in which the 
individual is included) once the individual is covered under the plan or 
coverage, unless the individual (or a person seeking coverage on behalf 
of the individual) performs an act, practice, or omission that 
constitutes fraud, or unless the individual makes an intentional 
misrepresentation of material fact, as prohibited by the terms of the 
plan or coverage. A group health plan, or a health insurance issuer 
offering group health insurance coverage, must provide at least 30 days 
advance written notice to each participant who would be affected before 
coverage may be rescinded under this paragraph (a)(1), regardless of 
whether the coverage is insured or self-insured, or whether the 
rescission applies to an entire group or only to an individual within 
the group. (The rules of this paragraph (a)(1) apply regardless of any 
contestability period that may otherwise apply.)
    (2) For purposes of this section, a rescission is a cancellation or 
discontinuance of coverage that has retroactive effect. For example, a 
cancellation that treats a policy as void from the

[[Page 482]]

time of the individual's or group's enrollment is a rescission. As 
another example, a cancellation that voids benefits paid up to a year 
before the cancellation is also a rescission for this purpose. A 
cancellation or discontinuance of coverage is not a rescission if--
    (i) The cancellation or discontinuance of coverage has only a 
prospective effect; or
    (ii) The cancellation or discontinuance of coverage is effective 
retroactively to the extent it is attributable to a failure to timely 
pay required premiums or contributions towards the cost of coverage.
    (3) The rules of this paragraph (a) are illustrated by the following 
examples:

    Example 1. (i) Facts. Individual A seeks enrollment in an insured 
group health plan. The plan terms permit rescission of coverage with 
respect to an individual if the individual engages in fraud or makes an 
intentional misrepresentation of a material fact. The plan requires A to 
complete a questionnaire regarding A's prior medical history, which 
affects setting the group rate by the health insurance issuer. The 
questionnaire complies with the other requirements of this part. The 
questionnaire includes the following question: ``Is there anything else 
relevant to your health that we should know?'' A inadvertently fails to 
list that A visited a psychologist on two occasions, six years 
previously. A is later diagnosed with breast cancer and seeks benefits 
under the plan. On or around the same time, the issuer receives 
information about A's visits to the psychologist, which was not 
disclosed in the questionnaire.
    (ii) Conclusion. In this Example 1, the plan cannot rescind A's 
coverage because A's failure to disclose the visits to the psychologist 
was inadvertent. Therefore, it was not fraudulent or an intentional 
misrepresentation of material fact.
    Example 2. (i) Facts. An employer sponsors a group health plan that 
provides coverage for employees who work at least 30 hours per week. 
Individual B has coverage under the plan as a full-time employee. The 
employer reassigns B to a part-time position. Under the terms of the 
plan, B is no longer eligible for coverage. The plan mistakenly 
continues to provide health coverage, collecting premiums from B and 
paying claims submitted by B. After a routine audit, the plan discovers 
that B no longer works at least 30 hours per week. The plan rescinds B's 
coverage effective as of the date that B changed from a full-time 
employee to a part-time employee.
    (ii) Conclusion. In this Example 2, the plan cannot rescind B's 
coverage because there was no fraud or an intentional misrepresentation 
of material fact. The plan may cancel coverage for B prospectively, 
subject to other applicable Federal and State laws.

    (b) Compliance with other requirements. Other requirements of 
Federal or State law may apply in connection with a rescission of 
coverage.
    (c) Effective/applicability date. The provisions of this section 
apply for plan years beginning on or after September 23, 2010. See Sec. 
54.9815-1251T for determining the application of this section to 
grandfathered health plans (providing that the rules regarding 
rescissions and advance notice apply to all grandfathered health plans).
    (d) Expiration date. This section expires on June 21, 2013.

[T.D. 9491, 75 FR 37225, June 28, 2010]



Sec. 54.9815-2713  Coverage of preventive health services.

    (a) Services--(1) In general. [Reserved]
    (i)-(iii) [Reserved]
    (iv) With respect to women, to the extent not described in paragraph 
(a)(1)(i) of Sec. 54.9815-2713T, preventive care and screenings 
provided for in binding comprehensive health plan coverage guidelines 
supported by the Health Resources and Services Administration and 
developed in accordance with 45 CFR 147.130(a)(1)(iv).
    (2) Office visits. [Reserved]
    (3) Out-of-network providers. [Reserved]
    (4) Reasonable medical management. [Reserved]
    (5) Services not described. [Reserved]
    (b) Timing. [Reserved]
    (c) Recommendations not current. [Reserved]
    (d) Effective/applicability date. April 16, 2012.

[T.D. 9578, 77 FR 8729, Feb. 15, 2012]

    Effective Date Note: By T.D. 9578, 77 FR 8729, Feb. 15, 2012, Sec. 
54.9815-2713 was added, effective Apr. 16, 2012.



Sec. 54.9815-2713T  Coverage of preventive health services (temporary).

    (a) Services--(1) In general. Beginning at the time described in 
paragraph (b) of this section, a group health plan, or a health 
insurance issuer offering group health insurance coverage, must

[[Page 483]]

provide coverage for all of the following items and services, and may 
not impose any cost-sharing requirements (such as a copayment, 
coinsurance, or deductible) with respect to those items or services:
    (i) Evidence-based items or services that have in effect a rating of 
A or B in the current recommendations of the United States Preventive 
Services Task Force with respect to the individual involved (except as 
otherwise provided in paragraph (c) of this section);
    (ii) Immunizations for routine use in children, adolescents, and 
adults that have in effect a recommendation from the Advisory Committee 
on Immunization Practices of the Centers for Disease Control and 
Prevention with respect to the individual involved (for this purpose, a 
recommendation from the Advisory Committee on Immunization Practices of 
the Centers for Disease Control and Prevention is considered in effect 
after it has been adopted by the Director of the Centers for Disease 
Control and Prevention, and a recommendation is considered to be for 
routine use if it is listed on the Immunization Schedules of the Centers 
for Disease Control and Prevention);
    (iii) With respect to infants, children, and adolescents, evidence-
informed preventive care and screenings provided for in comprehensive 
guidelines supported by the Health Resources and Services 
Administration; and
    (iv) With respect to women, to the extent not described in paragraph 
(a)(1)(i) of this section, preventive care and screenings provided for 
in binding comprehensive health plan coverage guidelines supported by 
the Health Resources and Services Administration and developed in 
accordance with 45 CFR 147.130(a)(1)(iv).
    (2) Office visits--(i) If an item or service described in paragraph 
(a)(1) of this section is billed separately (or is tracked as individual 
encounter data separately) from an office visit, then a plan or issuer 
may impose cost-sharing requirements with respect to the office visit.
    (ii) If an item or service described in paragraph (a)(1) of this 
section is not billed separately (or is not tracked as individual 
encounter data separately) from an office visit and the primary purpose 
of the office visit is the delivery of such an item or service, then a 
plan or issuer may not impose cost-sharing requirements with respect to 
the office visit.
    (iii) If an item or service described in paragraph (a)(1) of this 
section is not billed separately (or is not tracked as individual 
encounter data separately) from an office visit and the primary purpose 
of the office visit is not the delivery of such an item or service, then 
a plan or issuer may impose cost-sharing requirements with respect to 
the office visit.
    (iv) The rules of this paragraph (a)(2) are illustrated by the 
following examples:

    Example 1. (i) Facts. An individual covered by a group health plan 
visits an in-network health care provider. While visiting the provider, 
the individual is screened for cholesterol abnormalities, which has in 
effect a rating of A or B in the current recommendations of the United 
States Preventive Services Task Force with respect to the individual. 
The provider bills the plan for an office visit and for the laboratory 
work of the cholesterol screening test.
    (ii) Conclusion. In this Example 1, the plan may not impose any 
cost-sharing requirements with respect to the separately-billed 
laboratory work of the cholesterol screening test. Because the office 
visit is billed separately from the cholesterol screening test, the plan 
may impose cost-sharing requirements for the office visit.
    Example 2. (i) Facts. Same facts as Example 1. As the result of the 
screening, the individual is diagnosed with hyperlipidemia and is 
prescribed a course of treatment that is not included in the 
recommendations under paragraph (a)(1) of this section.
    (ii) Conclusion. In this Example 2, because the treatment is not 
included in the recommendations under paragraph (a)(1) of this section, 
the plan is not prohibited from imposing cost-sharing requirements with 
respect to the treatment.
    Example 3. (i) Facts. An individual covered by a group health plan 
visits an in-network health care provider to discuss recurring abdominal 
pain. During the visit, the individual has a blood pressure screening, 
which has in effect a rating of A or B in the current recommendations of 
the United States Preventive Services Task Force with respect to the 
individual. The provider bills the plan for an office visit.
    (ii) Conclusion. In this Example 3, the blood pressure screening is 
provided as part of an office visit for which the primary purpose was 
not to deliver items or services described

[[Page 484]]

in paragraph (a)(1) of this section. Therefore, the plan may impose a 
cost-sharing requirement for the office visit charge.
    Example 4. (i) Facts. A child covered by a group health plan visits 
an in-network pediatrician to receive an annual physical exam described 
as part of the comprehensive guidelines supported by the Health 
Resources and Services Administration. During the office visit, the 
child receives additional items and services that are not described in 
the comprehensive guidelines supported by the Health Resources and 
Services Administration, nor otherwise described in paragraph (a)(1) of 
this section. The provider bills the plan for an office visit.
    (ii) Conclusion. In this Example 4, the service was not billed as a 
separate charge and was billed as part of an office visit. Moreover, the 
primary purpose for the visit was to deliver items and services 
described as part of the comprehensive guidelines supported by the 
Health Resources and Services Administration. Therefore, the plan may 
not impose a cost-sharing requirement with respect to the office visit.

    (3) Out-of-network providers. Nothing in this section requires a 
plan or issuer that has a network of providers to provide benefits for 
items or services described in paragraph (a)(1) of this section that are 
delivered by an out-of-network provider. Moreover, nothing in this 
section precludes a plan or issuer that has a network of providers from 
imposing cost-sharing requirements for items or services described in 
paragraph (a)(1) of this section that are delivered by an out-of-network 
provider.
    (4) Reasonable medical management. Nothing prevents a plan or issuer 
from using reasonable medical management techniques to determine the 
frequency, method, treatment, or setting for an item or service 
described in paragraph (a)(1) of this section to the extent not 
specified in the recommendation or guideline.
    (5) Services not described. Nothing in this section prohibits a plan 
or issuer from providing coverage for items and services in addition to 
those recommended by the United States Preventive Services Task Force or 
the Advisory Committee on Immunization Practices of the Centers for 
Disease Control and Prevention, or provided for by guidelines supported 
by the Health Resources and Services Administration, or from denying 
coverage for items and services that are not recommended by that task 
force or that advisory committee, or under those guidelines. A plan or 
issuer may impose cost-sharing requirements for a treatment not 
described in paragraph (a)(1) of this section, even if the treatment 
results from an item or service described in paragraph (a)(1) of this 
section.
    (b) Timing--(1) In general. A plan or issuer must provide coverage 
pursuant to paragraph (a)(1) of this section for plan years that begin 
on or after September 23, 2010, or, if later, for plan years that begin 
on or after the date that is one year after the date the recommendation 
or guideline is issued.
    (2) Changes in recommendations or guidelines. A plan or issuer is 
not required under this section to provide coverage for any items and 
services specified in any recommendation or guideline described in 
paragraph (a)(1) of this section after the recommendation or guideline 
is no longer described in paragraph (a)(1) of this section. Other 
requirements of Federal or State law may apply in connection with a plan 
or issuer ceasing to provide coverage for any such items or services, 
including PHS Act section 2715(d)(4), which requires a plan or issuer to 
give 60 days advance notice to an enrollee before any material 
modification will become effective.
    (c) Recommendations not current. For purposes of paragraph (a)(1)(i) 
of this section, and for purposes of any other provision of law, 
recommendations of the United States Preventive Services Task Force 
regarding breast cancer screening, mammography, and prevention issued in 
or around November 2009 are not considered to be current.
    (d) Effective/applicability date. The provisions of this section 
apply for plan years beginning on or after September 23, 2010. See Sec. 
54.9815-1251T for determining the application of this section to 
grandfathered health plans (providing that these rules regarding 
coverage of preventive health services do not apply to grandfathered 
health plans).
    (e) Expiration date. This section expires on July 12, 2013 or on 
such earlier

[[Page 485]]

date as may be provided in final regulations or other action published 
in the Federal Register.

[T.D. 9493, 75 FR 41756, July 19, 2010, as amended by T.D. 9541, 76 FR 
46625, Aug. 3, 2011]

    Effective Date Note: By T.D. 9578, 77 FR 8729, Feb. 15, 2012, Sec. 
54.9815-2713T was amended in paragraph (a)(1)(iii) by removing ``; and'' 
and adding a period in its place, and by removing paragraph (a)(1)(iv), 
effective Apr. 16, 2012.



Sec. 54.9815-2714T  Eligibility of children until at least age 26 
(temporary).

    (a) In general--(1) A group health plan, or a health insurance 
issuer offering group health insurance coverage, that makes available 
dependent coverage of children must make such coverage available for 
children until attainment of 26 years of age.
    (2) The rule of this paragraph (a) is illustrated by the following 
example:

    Example. (i) Facts. For the plan year beginning January 1, 2011, a 
group health plan provides health coverage for employees, employees' 
spouses, and employees' children until the child turns 26. On the 
birthday of a child of an employee, July 17, 2011, the child turns 26. 
The last day the plan covers the child is July 16, 2011.
    (ii) Conclusion. In this Example, the plan satisfies the requirement 
of this paragraph (a) with respect to the child.

    (b) Restrictions on plan definition of dependent. With respect to a 
child who has not attained age 26, a plan or issuer may not define 
dependent for purposes of eligibility for dependent coverage of children 
other than in terms of a relationship between a child and the 
participant. Thus, for example, a plan or issuer may not deny or 
restrict coverage for a child who has not attained age 26 based on the 
presence or absence of the child's financial dependency (upon the 
participant or any other person), residency with the participant or with 
any other person, student status, employment, or any combination of 
those factors. In addition, a plan or issuer may not deny or restrict 
coverage of a child based on eligibility for other coverage, except that 
paragraph (g) of this section provides a special rule for plan years 
beginning before January 1, 2014 for grandfathered health plans that are 
group health plans. (Other requirements of Federal or State law, 
including section 609 of ERISA or section 1908 of the Social Security 
Act, may mandate coverage of certain children.)
    (c) Coverage of grandchildren not required. Nothing in this section 
requires a plan or issuer to make coverage available for the child of a 
child receiving dependent coverage.
    (d) Uniformity irrespective of age. The terms of the plan or health 
insurance coverage providing dependent coverage of children cannot vary 
based on age (except for children who are age 26 or older).
    (e) Examples. The rules of paragraph (d) of this section are 
illustrated by the following examples:

    Example 1. (i) Facts. A group health plan offers a choice of self-
only or family health coverage. Dependent coverage is provided under 
family health coverage for children of participants who have not 
attained age 26. The plan imposes an additional premium surcharge for 
children who are older than age 18.
    (ii) Conclusion. In this Example 1, the plan violates the 
requirement of paragraph (d) of this section because the plan varies the 
terms for dependent coverage of children based on age.
    Example 2. (i) Facts. A group health plan offers a choice among the 
following tiers of health coverage: self-only, self-plus-one, self-plus-
two, and self-plus-three-or-more. The cost of coverage increases based 
on the number of covered individuals. The plan provides dependent 
coverage of children who have not attained age 26.
    (ii) Conclusion. In this Example 2, the plan does not violate the 
requirement of paragraph (d) of this section that the terms of dependent 
coverage for children not vary based on age. Although the cost of 
coverage increases for tiers with more covered individuals, the increase 
applies without regard to the age of any child.
    Example 3. (i) Facts. A group health plan offers two benefit 
packages--an HMO option and an indemnity option. Dependent coverage is 
provided for children of participants who have not attained age 26. The 
plan limits children who are older than age 18 to the HMO option.
    (ii) Conclusion. In this Example 3, the plan violates the 
requirement of paragraph (d) of this section because the plan, by 
limiting children who are older than age 18 to the HMO option, varies 
the terms for dependent coverage of children based on age.


[[Page 486]]


    (f) Transitional rules for individuals whose coverage ended by 
reason of reaching a dependent eligibility threshold--(1) In general. 
The relief provided in the transitional rules of this paragraph (f) 
applies with respect to any child--
    (i) Whose coverage ended, or who was denied coverage (or was not 
eligible for coverage) under a group health plan or group health 
insurance coverage because, under the terms of the plan or coverage, the 
availability of dependent coverage of children ended before the 
attainment of age 26 (which, under this section, is no longer 
permissible); and
    (ii) Who becomes eligible (or is required to become eligible) for 
coverage under a group health plan or group health insurance coverage on 
the first day of the first plan year beginning on or after September 23, 
2010 by reason of the application of this section.
    (2) Opportunity to enroll required. (i) If a group health plan, or 
group health insurance coverage, in which a child described in paragraph 
(f)(1) of this section is eligible to enroll (or is required to become 
eligible to enroll) is the plan or coverage in which the child's 
coverage ended (or did not begin) for the reasons described in paragraph 
(f)(1)(i) of this section, and if the plan, or the issuer of such 
coverage, is subject to the requirements of this section, the plan and 
the issuer are required to give the child an opportunity to enroll that 
continues for at least 30 days (including written notice of the 
opportunity to enroll). This opportunity (including the written notice) 
must be provided beginning not later than the first day of the first 
plan year beginning on or after September 23, 2010.
    (ii) The written notice must include a statement that children whose 
coverage ended, or who were denied coverage (or were not eligible for 
coverage), because the availability of dependent coverage of children 
ended before attainment of age 26 are eligible to enroll in the plan or 
coverage. The notice may be provided to an employee on behalf of the 
employee's child. In addition, the notice may be included with other 
enrollment materials that a plan distributes to employees, provided the 
statement is prominent. If a notice satisfying the requirements of this 
paragraph (f)(2) is provided to an employee whose child is entitled to 
an enrollment opportunity under this paragraph (f), the obligation to 
provide the notice of enrollment opportunity under this paragraph (f)(2) 
with respect to that child is satisfied for both the plan and the 
issuer.
    (3) Effective date of coverage. In the case of an individual who 
enrolls under paragraph (f)(2) of this section, coverage must take 
effect not later than the first day of the first plan year beginning on 
or after September 23, 2010.
    (4) Treatment of enrollees in a group health plan. Any child 
enrolling in a group health plan pursuant to paragraph (f)(2) of this 
section must be treated as if the child were a special enrollee, as 
provided under the rules of Sec. 54.9801-6(d). Accordingly, the child 
(and, if the child would not be a participant once enrolled in the plan, 
the participant through whom the child is otherwise eligible for 
coverage under the plan) must be offered all the benefit packages 
available to similarly situated individuals who did not lose coverage by 
reason of cessation of dependent status. For this purpose, any 
difference in benefits or cost-sharing requirements constitutes a 
different benefit package. The child also cannot be required to pay more 
for coverage than similarly situated individuals who did not lose 
coverage by reason of cessation of dependent status.
    (5) Examples. The rules of this paragraph (f) are illustrated by the 
following examples:

    Example 1. (i) Facts. Employer Y maintains a group health plan with 
a calendar year plan year. The plan has a single benefit package. For 
the 2010 plan year, the plan allows children of employees to be covered 
under the plan until age 19, or until age 23 for children who are full-
time students. Individual B, an employee of Y, and Individual C, B's 
child and a full-time student, were enrolled in Y's group health plan at 
the beginning of the 2010 plan year. On June 10, 2010, C turns 23 years 
old and loses dependent coverage under Y's plan. On or before January 1, 
2011, Y's group health plan gives B written notice that individuals who 
lost coverage by reason of ceasing to be a dependent before attainment 
of age 26 are eligible to enroll in the plan, and that individuals may 
request enrollment for such children through February 14, 2011 with 
enrollment effective retroactively to January 1, 2011.

[[Page 487]]

    (ii) Conclusion. In this Example 1, the plan has complied with the 
requirements of this paragraph (f) by providing an enrollment 
opportunity to C that lasts at least 30 days.
    Example 2. (i) Facts. Employer Z maintains a group health plan with 
a plan year beginning October 1 and ending September 30. Prior to 
October 1, 2010, the group health plan allows children of employees to 
be covered under the plan until age 22. Individual D, an employee of Z, 
and Individual E, D's child, are enrolled in family coverage under Z's 
group health plan for the plan year beginning on October 1, 2008. On May 
1, 2009, E turns 22 years old and ceases to be eligible as a dependent 
under Z's plan and loses coverage. D drops coverage but remains an 
employee of Z.
    (ii) Conclusion. In this Example 2, not later than October 1, 2010, 
the plan must provide D and E an opportunity to enroll (including 
written notice of an opportunity to enroll) that continues for at least 
30 days, with enrollment effective not later than October 1, 2010.
    Example 3. (i) Facts. Same facts as Example 2, except that D did not 
drop coverage. Instead, D switched to a lower-cost benefit package 
option.
    (ii) Conclusion. In this Example 3, not later than October 1, 2010, 
the plan must provide D and E an opportunity to enroll in any benefit 
package available to similarly situated individuals who enroll when 
first eligible.
    Example 4. (i) Facts. Same facts as Example 2, except that E elected 
COBRA continuation coverage.
    (ii) Conclusion. In this Example 4, not later than October 1, 2010, 
the plan must provide D and E an opportunity to enroll other than as a 
COBRA qualified beneficiary (and must provide, by that date, written 
notice of the opportunity to enroll) that continues for at least 30 
days, with enrollment effective not later than October 1, 2010.
    Example 5. (i) Facts. Employer X maintains a group health plan with 
a calendar year plan year. Prior to 2011, the plan allows children of 
employees to be covered under the plan until the child attains age 22. 
During the 2009 plan year, an individual with a 22-year old child joins 
the plan; the child is denied coverage because the child is 22.
    (ii) Conclusion. In this Example 5, notwithstanding that the child 
was not previously covered under the plan, the plan must provide the 
child, not later than January 1, 2011, an opportunity to enroll 
(including written notice to the employee of an opportunity to enroll 
the child) that continues for at least 30 days, with enrollment 
effective not later than January 1, 2011.
    (g) Special rule for grandfathered group health plans--(1) For plan 
years beginning before January 1, 2014, a group health plan that 
qualifies as a grandfathered health plan under section 1251 of the 
Patient Protection and Affordable Care Act and that makes available 
dependent coverage of children may exclude an adult child who has not 
attained age 26 from coverage only if the adult child is eligible to 
enroll in an eligible employer-sponsored health plan (as defined in 
section 5000A(f)(2)) other than a group health plan of a parent.
    (2) For plan years beginning on or after January 1, 2014, a group 
health plan that qualifies as a grandfathered health plan under section 
1251 of the Patient Protection and Affordable Care Act must comply with 
the requirements of paragraphs (a) through (f) of this section.
    (h) Applicability date. The provisions of this section apply for 
plan years beginning on or after September 23, 2010. See Sec. 54.9815-
1251T for determining the application of this section to grandfathered 
health plans.
    (i) Expiration date. This section expires on or before May 10, 2013.

[T.D. 9482, 75 FR 27134, May 13, 2010, as amended by T.D. 9489, 75 FR 
34562, June 17, 2010]



Sec. 54.9815-2715  Summary of benefits and coverage and uniform glossary.

    (a) Summary of benefits and coverage--(1) In general. A group health 
plan (and its administrator as defined in section 3(16)(A) of ERISA), 
and a health insurance issuer offering group health insurance coverage, 
is required to provide a written summary of benefits and coverage (SBC) 
for each benefit package without charge to entities and individuals 
described in this paragraph (a)(1) in accordance with the rules of this 
section.
    (i) SBC provided by a group health insurance issuer to a group 
health plan--(A) Upon application. A health insurance issuer offering 
group health insurance coverage must provide the SBC to a group health 
plan (or its sponsor) upon application for health coverage, as soon as 
practicable following receipt of the application, but in no event later 
than seven business days following receipt of the application.
    (B) By first day of coverage (if there are changes). If there is any 
change in the information required to be in the SBC that was provided 
upon application and

[[Page 488]]

before the first day of coverage, the issuer must update and provide a 
current SBC to the plan (or its sponsor) no later than the first day of 
coverage.
    (C) Upon renewal. If the issuer renews or reissues the policy, 
certificate, or contract of insurance (for example, for a succeeding 
policy year), the issuer must provide a new SBC as follows:
    (1) If written application is required (in either paper or 
electronic form) for renewal or reissuance, the SBC must be provided no 
later than the date the written application materials are distributed.
    (2) If renewal or reissuance is automatic, the SBC must be provided 
no later than 30 days prior to the first day of the new plan or policy 
year; however, with respect to an insured plan, if the policy, 
certificate, or contract of insurance has not been issued or renewed 
before such 30-day period, the SBC must be provided as soon as 
practicable but in no event later than seven business days after 
issuance of the new policy, certificate, or contract of insurance, or 
the receipt of written confirmation of intent to renew, whichever is 
earlier.
    (D) Upon request. If a group health plan (or its sponsor) requests 
an SBC or summary information about a health insurance product from a 
health insurance issuer offering group health insurance coverage, an SBC 
must be provided as soon as practicable, but in no event later than 
seven business days following receipt of the request.
    (ii) SBC provided by a group health insurance issuer and a group 
health plan to participants and beneficiaries--(A) In general. A group 
health plan (including its administrator, as defined under section 3(16) 
of ERISA), and a health insurance issuer offering group health insurance 
coverage, must provide an SBC to a participant or beneficiary (as 
defined under sections 3(7) and 3(8) of ERISA), and consistent with 
paragraph (a)(1)(iii) of this section, with respect to each benefit 
package offered by the plan or issuer for which the participant or 
beneficiary is eligible.
    (B) Upon application. The SBC must be provided as part of any 
written application materials that are distributed by the plan or issuer 
for enrollment. If the plan or issuer does not distribute written 
application materials for enrollment, the SBC must be distributed no 
later than the first date on which the participant is eligible to enroll 
in coverage for the participant or any beneficiaries.
    (C) By first day of coverage (if there are changes). If there is any 
change to the information required to be in the SBC that was provided 
upon application and before the first day of coverage, the plan or 
issuer must update and provide a current SBC to a participant or 
beneficiary no later than the first day of coverage.
    (D) Special enrollees. The plan or issuer must provide the SBC to 
special enrollees (as described in Sec. 54.9801-6) no later than the 
date by which a summary plan description is required to be provided 
under the timeframe set forth in ERISA section 104(b)(1)(A) and its 
implementing regulations, which is 90 days from enrollment.
    (E) Upon renewal. If the plan or issuer requires participants or 
beneficiaries to renew in order to maintain coverage (for example, for a 
succeeding plan year), the plan or issuer must provide a new SBC when 
the coverage is renewed, as follows:
    (1) If written application is required for renewal (in either paper 
or electronic form), the SBC must be provided no later than the date on 
which the written application materials are distributed.
    (2) If renewal is automatic, the SBC must be provided no later than 
30 days prior to the first day of the new plan or policy year; however, 
with respect to an insured plan, if the policy, certificate, or contract 
of insurance has not been issued or renewed before such 30-day period, 
the SBC must be provided as soon as practicable but in no event later 
than seven business days after issuance of the new policy, certificate, 
or contract of insurance, or the receipt of written confirmation of 
intent to renew, whichever is earlier.
    (F) Upon request. A plan or issuer must provide the SBC to 
participants or beneficiaries upon request for an SBC or summary 
information about the health coverage, as soon as practicable, but in no 
event later than seven business days following receipt of the request.

[[Page 489]]

    (iii) Special rules to prevent unnecessary duplication with respect 
to group health coverage--(A) An entity required to provide an SBC under 
this paragraph (a)(1) with respect to an individual satisfies that 
requirement if another party provides the SBC, but only to the extent 
that the SBC is timely and complete in accordance with the other rules 
of this section. Therefore, for example, in the case of a group health 
plan funded through an insurance policy, the plan satisfies the 
requirement to provide an SBC with respect to an individual if the 
issuer provides a timely and complete SBC to the individual.
    (B) If a single SBC is provided to a participant and any 
beneficiaries at the participant's last known address, then the 
requirement to provide the SBC to the participant and any beneficiaries 
is generally satisfied. However, if a beneficiary's last known address 
is different than the participant's last known address, a separate SBC 
is required to be provided to the beneficiary at the beneficiary's last 
known address.
    (C) With respect to a group health plan that offers multiple benefit 
packages, the plan or issuer is required to provide a new SBC 
automatically upon renewal only with respect to the benefit package in 
which a participant or beneficiary is enrolled; SBCs are not required to 
be provided automatically upon renewal with respect to benefit packages 
in which the participant or beneficiary is not enrolled. However, if a 
participant or beneficiary requests an SBC with respect to another 
benefit package (or more than one other benefit package) for which the 
participant or beneficiary is eligible, the SBC (or SBCs, in the case of 
a request for SBCs relating to more than one benefit package) must be 
provided upon request as soon as practicable, but in no event later than 
seven business days following receipt of the request.
    (2) Content--(i) In general. Subject to paragraph (a)(2)(iii) of 
this section, the SBC must include the following:
    (A) Uniform definitions of standard insurance terms and medical 
terms so that consumers may compare health coverage and understand the 
terms of (or exceptions to) their coverage, in accordance with guidance 
as specified by the Secretary;
    (B) A description of the coverage, including cost sharing, for each 
category of benefits identified by the Secretary in guidance;
    (C) The exceptions, reductions, and limitations of the coverage;
    (D) The cost-sharing provisions of the coverage, including 
deductible, coinsurance, and copayment obligations;
    (E) The renewability and continuation of coverage provisions;
    (F) Coverage examples, in accordance with paragraph (a)(2)(ii) of 
this section;
    (G) With respect to coverage beginning on or after January 1, 2014, 
a statement about whether the plan or coverage provides minimum 
essential coverage as defined under section 5000A(f) and whether the 
plan's or coverage's share of the total allowed costs of benefits 
provided under the plan or coverage meets applicable requirements;
    (H) A statement that the SBC is only a summary and that the plan 
document, policy, certificate, or contract of insurance should be 
consulted to determine the governing contractual provisions of the 
coverage;
    (I) Contact information for questions and obtaining a copy of the 
plan document or the insurance policy, certificate, or contract of 
insurance (such as a telephone number for customer service and an 
Internet address for obtaining a copy of the plan document or the 
insurance policy, certificate, or contract of insurance);
    (J) For plans and issuers that maintain one or more networks of 
providers, an Internet address (or similar contact information) for 
obtaining a list of network providers;
    (K) For plans and issuers that use a formulary in providing 
prescription drug coverage, an Internet address (or similar contact 
information) for obtaining information on prescription drug coverage; 
and
    (L) An Internet address for obtaining the uniform glossary, as 
described in paragraph (c) of this section, as well as a contact phone 
number to obtain a paper copy of the uniform glossary, and a disclosure 
that paper copies are available.

[[Page 490]]

    (ii) Coverage examples. The SBC must include coverage examples 
specified by the Secretary in guidance that illustrate benefits provided 
under the plan or coverage for common benefits scenarios (including 
pregnancy and serious or chronic medical conditions) in accordance with 
this paragraph (a)(2)(ii).
    (A) Number of examples. The Secretary may identify up to six 
coverage examples that may be required in an SBC.
    (B) Benefits scenarios. For purposes of this paragraph (a)(2)(ii), a 
benefits scenario is a hypothetical situation, consisting of a sample 
treatment plan for a specified medical condition during a specific 
period of time, based on recognized clinical practice guidelines as 
defined by the National Guideline Clearinghouse, Agency for Healthcare 
Research and Quality. The Secretary will specify, in guidance, the 
assumptions, including the relevant items and services and reimbursement 
information, for each claim in the benefits scenario.
    (C) Illustration of benefit provided. For purposes of this paragraph 
(a)(2)(ii), to illustrate benefits provided under the plan or coverage 
for a particular benefits scenario, a plan or issuer simulates claims 
processing in accordance with guidance issued by the Secretary to 
generate an estimate of what an individual might expect to pay under the 
plan, policy, or benefit package. The illustration of benefits provided 
will take into account any cost sharing, excluded benefits, and other 
limitations on coverage, as specified by the Secretary in guidance.
    (iii) Coverage provided outside the United States. In lieu of 
summarizing coverage for items and services provided outside the United 
States, a plan or issuer may provide an Internet address (or similar 
contact information) for obtaining information about benefits and 
coverage provided outside the United States. In any case, the plan or 
issuer must provide an SBC in accordance with this section that 
accurately summarizes benefits and coverage available under the plan or 
coverage within the United States.
    (3) Appearance. A group health plan and a health insurance issuer 
must provide an SBC in the form, and in accordance with the instructions 
for completing the SBC, that are specified by the Secretary in guidance. 
The SBC must be presented in a uniform format, use terminology 
understandable by the average plan enrollee, not exceed four double-
sided pages in length, and not include print smaller than 12-point font.
    (4) Form--(i) An SBC provided by an issuer offering group health 
insurance coverage to a plan (or its sponsor), may be provided in paper 
form. Alternatively, the SBC may be provided electronically (such as by 
email or an Internet posting) if the following three conditions are 
satisfied--
    (A) The format is readily accessible by the plan (or its sponsor);
    (B) The SBC is provided in paper form free of charge upon request; 
and
    (C) If the electronic form is an Internet posting, the issuer timely 
advises the plan (or its sponsor) in paper form or email that the 
documents are available on the Internet and provides the Internet 
address.
    (ii) An SBC provided by a group health plan or health insurance 
issuer to a participant or beneficiary may be provided in paper form. 
Alternatively, the SBC may be provided electronically (such as by email 
or an Internet posting) if the requirements of this paragraph (a)(4)(ii) 
are met.
    (A) With respect to participants and beneficiaries covered under the 
plan, the SBC may be provided electronically if the requirements of 29 
CFR 2520.104b-1 are met.
    (B) With respect to participants and beneficiaries who are eligible 
but not enrolled for coverage, the SBC may be provided electronically 
if--
    (1) The format is readily accessible;
    (2) The SBC is provided in paper form free of charge upon request; 
and
    (3) In a case in which the electronic form is an Internet posting, 
the plan or issuer timely notifies the individual in paper form (such as 
a postcard) or email that the documents are available on the Internet, 
provides the Internet address, and notifies the individual that the 
documents are available in paper form upon request.
    (5) Language. A group health plan or health insurance issuer must 
provide

[[Page 491]]

the SBC in a culturally and linguistically appropriate manner. For 
purposes of this paragraph (a)(5), a plan or issuer is considered to 
provide the SBC in a culturally and linguistically appropriate manner if 
the thresholds and standards of Sec. 54.9815-2719T(e) are met as 
applied to the SBC.
    (b) Notice of modification. If a group health plan, or health 
insurance issuer offering group health insurance coverage, makes any 
material modification (as defined under section 102 of ERISA) in any of 
the terms of the plan or coverage that would affect the content of the 
SBC, that is not reflected in the most recently provided SBC, and that 
occurs other than in connection with a renewal or reissuance of 
coverage, the plan or issuer must provide notice of the modification to 
enrollees not later than 60 days prior to the date on which the 
modification will become effective. The notice of modification must be 
provided in a form that is consistent with paragraph (a)(4) of this 
section.
    (c) Uniform glossary--(1) In general. A group health plan, and a 
health insurance issuer offering group health insurance coverage, must 
make available to participants and beneficiaries the uniform glossary 
described in paragraph (c)(2) of this section in accordance with the 
appearance and the form and manner requirements of paragraphs (c)(3) and 
(4) of this section.
    (2) Health-coverage-related terms and medical terms. The uniform 
glossary must provide uniform definitions, specified by the Secretary in 
guidance, of the following health-coverage-related terms and medical 
terms:
    (i) Allowed amount, appeal, balance billing, co-insurance, 
complications of pregnancy, co-payment, deductible, durable medical 
equipment, emergency medical condition, emergency medical 
transportation, emergency room care, emergency services, excluded 
services, grievance, habilitation services, health insurance, home 
health care, hospice services, hospitalization, hospital outpatient 
care, in-network co-insurance, in-network co-payment, medically 
necessary, network, non-preferred provider, out-of-network co-insurance, 
out-of-network co-payment, out-of-pocket limit, physician services, 
plan, preauthorization, preferred provider, premium, prescription drug 
coverage, prescription drugs, primary care physician, primary care 
provider, provider, reconstructive surgery, rehabilitation services, 
skilled nursing care, specialist, usual customary and reasonable (UCR), 
and urgent care; and
    (ii) Such other terms as the Secretary determines are important to 
define so that individuals and employers may compare and understand the 
terms of coverage and medical benefits (including any exceptions to 
those benefits), as specified in guidance.
    (3) Appearance. A group health plan, and a health insurance issuer, 
must provide the uniform glossary with the appearance specified by the 
Secretary in guidance to ensure the uniform glossary is presented in a 
uniform format and uses terminology understandable by the average plan 
enrollee.
    (4) Form and manner. A plan or issuer must make the uniform glossary 
described in this paragraph (c) available upon request, in either paper 
or electronic form (as requested), within seven business days after 
receipt of the request.
    (d) Preemption. State laws that require a health insurance issuer to 
provide an SBC that supplies less information than required under 
paragraph (a) of this section are preempted.
    (e) Failure to provide. A group health plan or health insurance 
issuer that willfully fails to provide information required under this 
section to a participant or beneficiary is subject to a fine of not more 
than $1,000 for each such failure. A failure with respect to each 
participant or beneficiary constitutes a separate offense for purposes 
of this paragraph (e).
    (f) Effective/Applicability date--(1) This section is applicable to 
group health plans and group health insurance issuers in accordance with 
this paragraph (f). (See Sec. 54.9815-1251T(d), providing that this 
section applies to grandfathered health plans.)
    (i) For disclosures with respect to participants and beneficiaries 
who enroll or re-enroll through an open enrollment period (including re-
enrollees and late enrollees), this section applies beginning on the 
first day of the first

[[Page 492]]

open enrollment period that begins on or after September 23, 2012; and
    (ii) For disclosures with respect to participants and beneficiaries 
who enroll in coverage other than through an open enrollment period 
(including individuals who are newly eligible for coverage and special 
enrollees), this section applies beginning on the first day of the first 
plan year that begins on or after September 23, 2012.
    (2) For disclosures with respect to plans, this section is 
applicable to health insurance issuers beginning September 23, 2012.

[T.D. 9575, 77 FR 8697, Feb. 14, 2012]

    Effective Date Note: By T.D. 9575, 77 FR 8697, Feb. 14, 2012, Sec. 
54.9515-2715 was added, effective Apr. 16, 2012.



Sec. 54.9815-2719AT  Patient protections (temporary).

    (a) Choice of health care professional--(1) Designation of primary 
care provider--(i) In general. If a group health plan, or a health 
insurance issuer offering group health insurance coverage, requires or 
provides for designation by a participant or beneficiary of a 
participating primary care provider, then the plan or issuer must permit 
each participant or beneficiary to designate any participating primary 
care provider who is available to accept the participant or beneficiary. 
In such a case, the plan or issuer must comply with the rules of 
paragraph (a)(4) of this section by informing each participant of the 
terms of the plan or health insurance coverage regarding designation of 
a primary care provider.
    (ii) Example. The rules of this paragraph (a)(1) are illustrated by 
the following example:

    Example. (i) Facts. A group health plan requires individuals covered 
under the plan to designate a primary care provider. The plan permits 
each individual to designate any primary care provider participating in 
the plan's network who is available to accept the individual as the 
individual's primary care provider. If an individual has not designated 
a primary care provider, the plan designates one until one has been 
designated by the individual. The plan provides a notice that satisfies 
the requirements of paragraph (a)(4) of this section regarding the 
ability to designate a primary care provider.
    (ii) Conclusion. In this Example, the plan has satisfied the 
requirements of paragraph (a) of this section.

    (2) Designation of pediatrician as primary care provider--(i) In 
general. If a group health plan, or a health insurance issuer offering 
group health insurance coverage, requires or provides for the 
designation of a participating primary care provider for a child by a 
participant or beneficiary, the plan or issuer must permit the 
participant or beneficiary to designate a physician (allopathic or 
osteopathic) who specializes in pediatrics as the child's primary care 
provider if the provider participates in the network of the plan or 
issuer and is available to accept the child. In such a case, the plan or 
issuer must comply with the rules of paragraph (a)(4) of this section by 
informing each participant of the terms of the plan or health insurance 
coverage regarding designation of a pediatrician as the child's primary 
care provider.
    (ii) Construction. Nothing in paragraph (a)(2)(i) of this section is 
to be construed to waive any exclusions of coverage under the terms and 
conditions of the plan or health insurance coverage with respect to 
coverage of pediatric care.
    (iii) Examples. The rules of this paragraph (a)(2) are illustrated 
by the following examples:

    Example 1. (i) Facts. A group health plan's HMO designates for each 
participant a physician who specializes in internal medicine to serve as 
the primary care provider for the participant and any beneficiaries. 
Participant A requests that Pediatrician B be designated as the primary 
care provider for A's child. B is a participating provider in the HMO's 
network.
    (ii) Conclusion. In this Example 1, the HMO must permit A's 
designation of B as the primary care provider for A's child in order to 
comply with the requirements of this paragraph (a)(2).
    Example 2. (i) Facts. Same facts as Example 1, except that A takes 
A's child to B for treatment of the child's severe shellfish allergies. 
B wishes to refer A's child to an allergist for treatment. The HMO, 
however, does not provide coverage for treatment of food allergies, nor 
does it have an allergist participating in its network, and it therefore 
refuses to authorize the referral.
    (ii) Conclusion. In this Example 2, the HMO has not violated the 
requirements of this paragraph (a)(2) because the exclusion of

[[Page 493]]

treatment for food allergies is in accordance with the terms of A's 
coverage.

    (3) Patient access to obstetrical and gynecological care--(i) 
General rights--(A) Direct access. A group health plan, or a health 
insurance issuer offering group health insurance coverage, described in 
paragraph (a)(3)(ii) of this section may not require authorization or 
referral by the plan, issuer, or any person (including a primary care 
provider) in the case of a female participant or beneficiary who seeks 
coverage for obstetrical or gynecological care provided by a 
participating health care professional who specializes in obstetrics or 
gynecology. In such a case, the plan or issuer must comply with the 
rules of paragraph (a)(4) of this section by informing each participant 
that the plan may not require authorization or referral for obstetrical 
or gynecological care by a participating health care professional who 
specializes in obstetrics or gynecology. The plan or issuer may require 
such a professional to agree to otherwise adhere to the plan's or 
issuer's policies and procedures, including procedures regarding 
referrals and obtaining prior authorization and providing services 
pursuant to a treatment plan (if any) approved by the plan or issuer. 
For purposes of this paragraph (a)(3), a health care professional who 
specializes in obstetrics or gynecology is any individual (including a 
person other than a physician) who is authorized under applicable State 
law to provide obstetrical or gynecological care.
    (B) Obstetrical and gynecological care. A group health plan or 
health insurance issuer described in paragraph (a)(3)(ii) of this 
section must treat the provision of obstetrical and gynecological care, 
and the ordering of related obstetrical and gynecological items and 
services, pursuant to the direct access described under paragraph 
(a)(3)(i)(A) of this section, by a participating health care 
professional who specializes in obstetrics or gynecology as the 
authorization of the primary care provider.
    (ii) Application of paragraph. A group health plan, or a health 
insurance issuer offering group health insurance coverage, is described 
in this paragraph (a)(3) if the plan or issuer--
    (A) Provides coverage for obstetrical or gynecological care; and
    (B) Requires the designation by a participant or beneficiary of a 
participating primary care provider.
    (iii) Construction. Nothing in paragraph (a)(3)(i) of this section 
is to be construed to--
    (A) Waive any exclusions of coverage under the terms and conditions 
of the plan or health insurance coverage with respect to coverage of 
obstetrical or gynecological care; or
    (B) Preclude the group health plan or health insurance issuer 
involved from requiring that the obstetrical or gynecological provider 
notify the primary care health care professional or the plan or issuer 
of treatment decisions.
    (iv) Examples. The rules of this paragraph (a)(3) are illustrated by 
the following examples:

    Example 1. (i) Facts. A group health plan requires each participant 
to designate a physician to serve as the primary care provider for the 
participant and the participant's family. Participant A, a female, 
requests a gynecological exam with Physician B, an in-network physician 
specializing in gynecological care. The group health plan requires prior 
authorization from A's designated primary care provider for the 
gynecological exam.
    (ii) Conclusion. In this Example 1, the group health plan has 
violated the requirements of this paragraph (a)(3) because the plan 
requires prior authorization from A's primary care provider prior to 
obtaining gynecological services.
    Example 2. (i) Facts. Same facts as Example 1 except that A seeks 
gynecological services from C, an out-of-network provider.
    (ii) Conclusion. In this Example 2, the group health plan has not 
violated the requirements of this paragraph (a)(3) by requiring prior 
authorization because C is not a participating health care provider.
    Example 3. (i) Facts. Same facts as Example 1 except that the group 
health plan only requires B to inform A's designated primary care 
physician of treatment decisions.
    (ii) Conclusion. In this Example 3, the group health plan has not 
violated the requirements of this paragraph (a)(3) because A has direct 
access to B without prior authorization. The fact that the group health 
plan requires notification of treatment decisions to the designated 
primary care physician does not violate this paragraph (a)(3).
    Example 4. (i) Facts. A group health plan requires each participant 
to designate a physician to serve as the primary care provider for the 
participant and the participant's

[[Page 494]]

family. The group health plan requires prior authorization before 
providing benefits for uterine fibroid embolization.
    (ii) Conclusion. In this Example 4, the plan requirement for prior 
authorization before providing benefits for uterine fibroid embolization 
does not violate the requirements of this paragraph (a)(3) because, 
though the prior authorization requirement applies to obstetrical 
services, it does not restrict access to any providers specializing in 
obstetrics or gynecology.

    (4) Notice of right to designate a primary care provider--(i) In 
general. If a group health plan or health insurance issuer requires the 
designation by a participant or beneficiary of a primary care provider, 
the plan or issuer must provide a notice informing each participant of 
the terms of the plan or health insurance coverage regarding designation 
of a primary care provider and of the rights--
    (A) Under paragraph (a)(1)(i) of this section, that any 
participating primary care provider who is available to accept the 
participant or beneficiary can be designated;
    (B) Under paragraph (a)(2)(i) of this section, with respect to a 
child, that any participating physician who specializes in pediatrics 
can be designated as the primary care provider; and
    (C) Under paragraph (a)(3)(i) of this section, that the plan may not 
require authorization or referral for obstetrical or gynecological care 
by a participating health care professional who specializes in 
obstetrics or gynecology.
    (ii) Timing. The notice described in paragraph (a)(4)(i) of this 
section must be included whenever the plan or issuer provides a 
participant with a summary plan description or other similar description 
of benefits under the plan or health insurance coverage.
    (iii) Model language. The following model language can be used to 
satisfy the notice requirement described in paragraph (a)(4)(i) of this 
section:
    (A) For plans and issuers that require or allow for the designation 
of primary care providers by participants or beneficiaries, insert:

    [Name of group health plan or health insurance issuer] generally 
[requires/allows] the designation of a primary care provider. You have 
the right to designate any primary care provider who participates in our 
network and who is available to accept you or your family members. [If 
the plan or health insurance coverage designates a primary care provider 
automatically, insert: Until you make this designation, [name of group 
health plan or health insurance issuer] designates one for you.] For 
information on how to select a primary care provider, and for a list of 
the participating primary care providers, contact the [plan 
administrator or issuer] at [insert contact information].

    (B) For plans and issuers that require or allow for the designation 
of a primary care provider for a child, add:

    For children, you may designate a pediatrician as the primary care 
provider.

    (C) For plans and issuers that provide coverage for obstetric or 
gynecological care and require the designation by a participant or 
beneficiary of a primary care provider, add:

    You do not need prior authorization from [name of group health plan 
or issuer] or from any other person (including a primary care provider) 
in order to obtain access to obstetrical or gynecological care from a 
health care professional in our network who specializes in obstetrics or 
gynecology. The health care professional, however, may be required to 
comply with certain procedures, including obtaining prior authorization 
for certain services, following a pre-approved treatment plan, or 
procedures for making referrals. For a list of participating health care 
professionals who specialize in obstetrics or gynecology, contact the 
[plan administrator or issuer] at [insert contact information].

    (b) Coverage of emergency services--(1) Scope. If a group health 
plan, or a health insurance issuer offering group health insurance 
coverage, provides any benefits with respect to services in an emergency 
department of a hospital, the plan or issuer must cover emergency 
services (as defined in paragraph (b)(4)(ii) of this section) consistent 
with the rules of this paragraph (b).
    (2) General rules. A plan or issuer subject to the requirements of 
this paragraph (b) must provide coverage for emergency services in the 
following manner--
    (i) Without the need for any prior authorization determination, even 
if the emergency services are provided on an out-of-network basis;
    (ii) Without regard to whether the health care provider furnishing 
the emergency services is a participating

[[Page 495]]

network provider with respect to the services;
    (iii) If the emergency services are provided out of network, without 
imposing any administrative requirement or limitation on coverage that 
is more restrictive than the requirements or limitations that apply to 
emergency services received from in-network providers;
    (iv) If the emergency services are provided out of network, by 
complying with the cost-sharing requirements of paragraph (b)(3) of this 
section; and
    (v) Without regard to any other term or condition of the coverage, 
other than--
    (A) The exclusion of or coordination of benefits;
    (B) An affiliation or waiting period permitted under part 7 of 
ERISA, part A of title XXVII of the PHS Act, or chapter 100 of the 
Internal Revenue Code; or
    (C) Applicable cost sharing.
    (3) Cost-sharing requirements--(i) Copayments and coinsurance. Any 
cost-sharing requirement expressed as a copayment amount or coinsurance 
rate imposed with respect to a participant or beneficiary for out-of-
network emergency services cannot exceed the cost-sharing requirement 
imposed with respect to a participant or beneficiary if the services 
were provided in-network. However, a participant or beneficiary may be 
required to pay, in addition to the in-network cost sharing, the excess 
of the amount the out-of-network provider charges over the amount the 
plan or issuer is required to pay under this paragraph (b)(3)(i). A 
group health plan or health insurance issuer complies with the 
requirements of this paragraph (b)(3) if it provides benefits with 
respect to an emergency service in an amount equal to the greatest of 
the three amounts specified in paragraphs (b)(3)(i)(A), (b)(3)(i)(B), 
and (b)(3)(i)(C) of this section (which are adjusted for in-network 
cost-sharing requirements).
    (A) The amount negotiated with in-network providers for the 
emergency service furnished, excluding any in-network copayment or 
coinsurance imposed with respect to the participant or beneficiary. If 
there is more than one amount negotiated with in-network providers for 
the emergency service, the amount described under this paragraph 
(b)(3)(i)(A) is the median of these amounts, excluding any in-network 
copayment or coinsurance imposed with respect to the participant or 
beneficiary. In determining the median described in the preceding 
sentence, the amount negotiated with each in-network provider is treated 
as a separate amount (even if the same amount is paid to more than one 
provider). If there is no per-service amount negotiated with in-network 
providers (such as under a capitation or other similar payment 
arrangement), the amount under this paragraph (b)(3)(i)(A) is 
disregarded.
    (B) The amount for the emergency service calculated using the same 
method the plan generally uses to determine payments for out-of-network 
services (such as the usual, customary, and reasonable amount), 
excluding any in-network copayment or coinsurance imposed with respect 
to the participant or beneficiary. The amount in this paragraph 
(b)(3)(i)(B) is determined without reduction for out-of-network cost 
sharing that generally applies under the plan or health insurance 
coverage with respect to out-of-network services. Thus, for example, if 
a plan generally pays 70 percent of the usual, customary, and reasonable 
amount for out-of-network services, the amount in this paragraph 
(b)(3)(i)(B) for an emergency service is the total (that is, 100 
percent) of the usual, customary, and reasonable amount for the service, 
not reduced by the 30 percent coinsurance that would generally apply to 
out-of-network services (but reduced by the in-network copayment or 
coinsurance that the individual would be responsible for if the 
emergency service had been provided in-network).
    (C) The amount that would be paid under Medicare (part A or part B 
of title XVIII of the Social Security Act, 42 U.S.C. 1395 et seq.) for 
the emergency service, excluding any in-network copayment or coinsurance 
imposed with respect to the participant or beneficiary.
    (ii) Other cost sharing. Any cost-sharing requirement other than a 
copayment or coinsurance requirement (such as a deductible or out-of-
pocket maximum) may be imposed with respect to

[[Page 496]]

emergency services provided out of network if the cost-sharing 
requirement generally applies to out-of-network benefits. A deductible 
may be imposed with respect to out-of-network emergency services only as 
part of a deductible that generally applies to out-of-network benefits. 
If an out-of-pocket maximum generally applies to out-of-network 
benefits, that out-of-pocket maximum must apply to out-of-network 
emergency services.
    (iii) Examples. The rules of this paragraph (b)(3) are illustrated 
by the following examples. In all of these examples, the group health 
plan covers benefits with respect to emergency services.

    Example 1. (i) Facts. A group health plan imposes a 25% coinsurance 
responsibility on individuals who are furnished emergency services, 
whether provided in network or out of network. If a covered individual 
notifies the plan within two business days after the day an individual 
receives treatment in an emergency department, the plan reduces the 
coinsurance rate to 15%.
    (ii) Conclusion. In this Example 1, the requirement to notify the 
plan in order to receive a reduction in the coinsurance rate does not 
violate the requirement that the plan cover emergency services without 
the need for any prior authorization determination. This is the result 
even if the plan required that it be notified before or at the time of 
receiving services at the emergency department in order to receive a 
reduction in the coinsurance rate.
    Example 2. (i) Facts. A group health plan imposes a $60 copayment on 
emergency services without preauthorization, whether provided in-network 
or out-of-network. If emergency services are preauthorized, the plan 
waives the copayment, even if it later determines the medical condition 
was not an emergency medical condition.
    (ii) Conclusion. In this Example 2, by requiring an individual to 
pay more for emergency services if the individual does not obtain prior 
authorization, the plan violates the requirement that the plan cover 
emergency services without the need for any prior authorization 
determination. (By contrast, if, to have the copayment waived, the plan 
merely required that it be notified rather than a prior authorization, 
then the plan would not violate the requirement that the plan cover 
emergency services without the need for any prior authorization 
determination.)
    Example 3. (i) Facts. A group health plan covers individuals who 
receive emergency services with respect to an emergency medical 
condition from an out-of-network provider. The plan has agreements with 
in-network providers with respect to a certain emergency service. Each 
provider has agreed to provide the service for a certain amount. Among 
all the providers for the service: One has agreed to accept $85, two 
have agreed to accept $100, two have agreed to accept $110, three have 
agreed to accept $120, and one has agreed to accept $150. Under the 
agreement, the plan agrees to pay the providers 80% of the agreed 
amount, with the individual receiving the service responsible for the 
remaining 20%.
    (ii) Conclusion. In this Example 3, the values taken into account in 
determining the median are $85, $100, $100, $110, $110, $120, $120, 
$120, and $150. Therefore, the median amount among those agreed to for 
the emergency service is $110, and the amount under paragraph 
(b)(3)(i)(A) of this section is 80% of $110 ($88).
    Example 4. (i) Facts. Same facts as Example 3. Subsequently, the 
plan adds another provider to its network, who has agreed to accept $150 
for the emergency service.
    (ii) Conclusion. In this Example 4, the median amount among those 
agreed to for the emergency service is $115. (Because there is no one 
middle amount, the median is the average of the two middle amounts, $110 
and $120.) Accordingly, the amount under paragraph (b)(3)(i)(A) of this 
section is 80% of $115 ($92).
    Example 5. (i) Facts. Same facts as Example 4. An individual covered 
by the plan receives the emergency service from an out-of-network 
provider, who charges $125 for the service. With respect to services 
provided by out-of-network providers generally, the plan reimburses 
covered individuals 50% of the reasonable amount charged by the provider 
for medical services. For this purpose, the reasonable amount for any 
service is based on information on charges by all providers collected by 
a third party, on a zip-code-by-zip-code basis, with the plan treating 
charges at a specified percentile as reasonable. For the emergency 
service received by the individual, the reasonable amount calculated 
using this method is $116. The amount that would be paid under Medicare 
for the emergency service, excluding any copayment or coinsurance for 
the service, is $80.
    (ii) Conclusion. In this Example 5, the plan is responsible for 
paying $92.80, 80% of $116. The median amount among those agreed to for 
the emergency service is $115 and the amount the plan would pay is $92 
(80% of $115); the amount calculated using the same method the plan uses 
to determine payments for out-of-network services--$116--excluding the 
in-network 20% coinsurance, is $92.80; and the Medicare payment is $80. 
Thus, the greatest amount is $92.80. The individual is responsible for 
the remaining $32.20 charged by the out-of-network provider.
    Example 6. (i) Facts. Same facts as Example 5. The group health plan 
generally imposes a

[[Page 497]]

$250 deductible for in-network health care. With respect to all health 
care provided by out-of-network providers, the plan imposes a $500 
deductible. (Covered in-network claims are credited against the 
deductible.) The individual has incurred and submitted $260 of covered 
claims prior to receiving the emergency service out of network.
    (ii) Conclusion. In this Example 6, the plan is not responsible for 
paying anything with respect to the emergency service furnished by the 
out-of-network provider because the covered individual has not satisfied 
the higher deductible that applies generally to all health care provided 
out of network. However, the amount the individual is required to pay is 
credited against the deductible.

    (4) Definitions. The definitions in this paragraph (b)(4) govern in 
applying the provisions of this paragraph (b).
    (i) Emergency medical condition. The term emergency medical 
condition means a medical condition manifesting itself by acute symptoms 
of sufficient severity (including severe pain) so that a prudent 
layperson, who possesses an average knowledge of health and medicine, 
could reasonably expect the absence of immediate medical attention to 
result in a condition described in clause (i), (ii), or (iii) of section 
1867(e)(1)(A) of the Social Security Act (42 U.S.C. 1395dd(e)(1)(A)). 
(In that provision of the Social Security Act, clause (i) refers to 
placing the health of the individual (or, with respect to a pregnant 
woman, the health of the woman or her unborn child) in serious jeopardy; 
clause (ii) refers to serious impairment to bodily functions; and clause 
(iii) refers to serious dysfunction of any bodily organ or part.)
    (ii) Emergency services. The term emergency services means, with 
respect to an emergency medical condition--
    (A) A medical screening examination (as required under section 1867 
of the Social Security Act, 42 U.S.C. 1395dd) that is within the 
capability of the emergency department of a hospital, including 
ancillary services routinely available to the emergency department to 
evaluate such emergency medical condition, and
    (B) Such further medical examination and treatment, to the extent 
they are within the capabilities of the staff and facilities available 
at the hospital, as are required under section 1867 of the Social 
Security Act (42 U.S.C. 1395dd) to stabilize the patient.
    (iii) Stabilize. The term to stabilize, with respect to an emergency 
medical condition (as defined in paragraph (b)(4)(i) of this section) 
has the meaning given in section 1867(e)(3) of the Social Security Act 
(42 U.S.C. 1395dd(e)(3)).
    (c) Effective/applicability date. The provisions of this section 
apply for plan years beginning on or after September 23, 2010. See Sec. 
54.9815-1251T for determining the application of this section to 
grandfathered health plans (providing that these rules regarding patient 
protections do not apply to grandfathered health plans).
    (d) Expiration date. This section expires on June 21, 2013.

[T.D. 9491, 75 FR 37225, June 28, 2010]



Sec. 54.9815-2719T  Internal claims and appeals and external review 
processes (temporary).

    (a) Scope and definitions--(1) Scope. This section sets forth 
requirements with respect to internal claims and appeals and external 
review processes for group health plans and health insurance issuers 
that are not grandfathered health plans under Sec. 54.9815-1251T. 
Paragraph (b) of this section provides requirements for internal claims 
and appeals processes. Paragraph (c) of this section sets forth rules 
governing the applicability of State external review processes. 
Paragraph (d) of this section sets forth a Federal external review 
process for plans and issuers not subject to an applicable State 
external review process. Paragraph (e) of this section prescribes 
requirements for ensuring that notices required to be provided under 
this section are provided in a culturally and linguistically appropriate 
manner. Paragraph (f) of this section describes the authority of the 
Secretary to deem certain external review processes in existence on 
March 23, 2010 as in compliance with paragraph (c) or (d) of this 
section. Paragraph (g) of this section sets forth the applicability date 
for this section.
    (2) Definitions. For purposes of this section, the following 
definitions apply--
    (i) Adverse benefit determination. An adverse benefit determination 
means an adverse benefit determination as defined in 29 CFR 2560.503-1, 
as well as

[[Page 498]]

any rescission of coverage, as described in Sec. 54.9815-2712T(a)(2) 
(whether or not, in connection with the rescission, there is an adverse 
effect on any particular benefit at that time).
    (ii) Appeal (or internal appeal). An appeal or internal appeal means 
review by a plan or issuer of an adverse benefit determination, as 
required in paragraph (b) of this section.
    (iii) Claimant. Claimant means an individual who makes a claim under 
this section. For purposes of this section, references to claimant 
include a claimant's authorized representative.
    (iv) External review. External review means a review of an adverse 
benefit determination (including a final internal adverse benefit 
determination) conducted pursuant to an applicable State external review 
process described in paragraph (c) of this section or the Federal 
external review process of paragraph (d) of this section.
    (v) Final internal adverse benefit determination. A final internal 
adverse benefit determination means an adverse benefit determination 
that has been upheld by a plan or issuer at the completion of the 
internal appeals process applicable under paragraph (b) of this section 
(or an adverse benefit determination with respect to which the internal 
appeals process has been exhausted under the deemed exhaustion rules of 
paragraph (b)(2)(ii)(F) of this section).
    (vi) Final external review decision. A final external review 
decision, as used in paragraph (d) of this section, means a 
determination by an independent review organization at the conclusion of 
an external review.
    (vii) Independent review organization (or IRO). An independent 
review organization (or IRO) means an entity that conducts independent 
external reviews of adverse benefit determinations and final internal 
adverse benefit determinations pursuant to paragraph (c) or (d) of this 
section.
    (viii) NAIC Uniform Model Act. The NAIC Uniform Model Act means the 
Uniform Health Carrier External Review Model Act promulgated by the 
National Association of Insurance Commissioners in place on July 23, 
2010.
    (b) Internal claims and appeals process--(1) In general. A group 
health plan and a health insurance issuer offering group health 
insurance coverage must implement an effective internal claims and 
appeals process, as described in this paragraph (b).
    (2) Requirements for group health plans and group health insurance 
issuers. A group health plan and a health insurance issuer offering 
group health insurance coverage must comply with all the requirements of 
this paragraph (b)(2). In the case of health insurance coverage offered 
in connection with a group health plan, if either the plan or the issuer 
complies with the internal claims and appeals process of this paragraph 
(b)(2), then the obligation to comply with this paragraph (b)(2) is 
satisfied for both the plan and the issuer with respect to the health 
insurance coverage.
    (i) Minimum internal claims and appeals standards. A group health 
plan and a health insurance issuer offering group health insurance 
coverage must comply with all the requirements applicable to group 
health plans under 29 CFR 2560.503-1, except to the extent those 
requirements are modified by paragraph (b)(2)(ii) of this section. 
Accordingly, under this paragraph (b), with respect to health insurance 
coverage offered in connection with a group health plan, the group 
health insurance issuer is subject to the requirements in 29 CFR 
2560.503-1 to the same extent as the group health plan.
    (ii) Additional standards. In addition to the requirements in 
paragraph (b)(2)(i) of this section, the internal claims and appeals 
processes of a group health plan and a health insurance issuer offering 
group health insurance coverage must meet the requirements of this 
paragraph (b)(2)(ii).
    (A) Clarification of meaning of adverse benefit determination. For 
purposes of this paragraph (b)(2), an ``adverse benefit determination'' 
includes an adverse benefit determination as defined in paragraph 
(a)(2)(i) of this section. Accordingly, in complying with 29 CFR 
2560.503-1, as well as the other provisions of this paragraph (b)(2), a 
plan or issuer must treat a rescission of coverage (whether or not the 
rescission has an adverse effect on any particular

[[Page 499]]

benefit at that time) as an adverse benefit determination. (Rescissions 
of coverage are subject to the requirements of Sec. 54.9815-2712T.)
    (B) Expedited notification of benefit determinations involving 
urgent care. The requirements of 29 CFR 2560.503-1(f)(2)(i) (which 
generally provide, among other things, in the case of urgent care claims 
for notification of the plan's benefit determination (whether adverse or 
not) as soon as possible, taking into account the medical exigencies, 
but not later than 72 hours after receipt of the claim) continue to 
apply to the plan and issuer. For purposes of this paragraph 
(b)(2)(ii)(B), a claim involving urgent care has the meaning given in 29 
CFR 2560.503-1(m)(1), as determined by the attending provider, and the 
plan or issuer shall defer to such determination of the attending 
provider.
    (C) Full and fair review. A plan and issuer must allow a claimant to 
review the claim file and to present evidence and testimony as part of 
the internal claims and appeals process. Specifically, in addition to 
complying with the requirements of 29 CFR 2560.503-1(h)(2)--
    (1) The plan or issuer must provide the claimant, free of charge, 
with any new or additional evidence considered, relied upon, or 
generated by the plan or issuer (or at the direction of the plan or 
issuer) in connection with the claim; such evidence must be provided as 
soon as possible and sufficiently in advance of the date on which the 
notice of final internal adverse benefit determination is required to be 
provided under 29 CFR 2560.503-1(i) to give the claimant a reasonable 
opportunity to respond prior to that date; and
    (2) Before the plan or issuer can issue a final internal adverse 
benefit determination based on a new or additional rationale, the 
claimant must be provided, free of charge, with the rationale; the 
rationale must be provided as soon as possible and sufficiently in 
advance of the date on which the notice of final internal adverse 
benefit determination is required to be provided under 29 CFR 2560.503-
1(i) to give the claimant a reasonable opportunity to respond prior to 
that date.
    (D) Avoiding conflicts of interest. In addition to the requirements 
of 29 CFR 2560.503-1(b) and (h) regarding full and fair review, the plan 
and issuer must ensure that all claims and appeals are adjudicated in a 
manner designed to ensure the independence and impartiality of the 
persons involved in making the decision. Accordingly, decisions 
regarding hiring, compensation, termination, promotion, or other similar 
matters with respect to any individual (such as a claims adjudicator or 
medical expert) must not be made based upon the likelihood that the 
individual will support the denial of benefits.
    (E) Notice. A plan and issuer must provide notice to individuals, in 
a culturally and linguistically appropriate manner (as described in 
paragraph (e) of this section) that complies with the requirements of 29 
CFR 2560.503-1(g) and (j). The plan and issuer must also comply with the 
additional requirements of this paragraph (b)(2)(ii)(E).
    (1) The plan and issuer must ensure that any notice of adverse 
benefit determination or final internal adverse benefit determination 
includes information sufficient to identify the claim involved 
(including the date of service, the health care provider, the claim 
amount (if applicable), and a statement describing the availability, 
upon request, of the diagnosis code and its corresponding meaning, and 
the treatment code and its corresponding meaning).
    (2) The plan and issuer must provide to participants and 
beneficiaries, as soon as practicable, upon request, the diagnosis code 
and its corresponding meaning, and the treatment code and its 
corresponding meaning, associated with any adverse benefit determination 
or final internal adverse benefit determination. The plan or issuer must 
not consider a request for such diagnosis and treatment information, in 
itself, to be a request for an internal appeal under this paragraph (b) 
or an external review under paragraphs (c) and (d) of this section.
    (3) The plan and issuer must ensure that the reason or reasons for 
the adverse benefit determination or final internal adverse benefit 
determination

[[Page 500]]

includes the denial code and its corresponding meaning, as well as a 
description of the plan's or issuer's standard, if any, that was used in 
denying the claim. In the case of a notice of final internal adverse 
benefit determination, this description must include a discussion of the 
decision.
    (4) The plan and issuer must provide a description of available 
internal appeals and external review processes, including information 
regarding how to initiate an appeal.
    (5) The plan and issuer must disclose the availability of, and 
contact information for, any applicable office of health insurance 
consumer assistance or ombudsman established under PHS Act section 2793 
to assist individuals with the internal claims and appeals and external 
review processes.
    (F) Deemed exhaustion of internal claims and appeals processes--(1) 
In the case of a plan or issuer that fails to adhere to all the 
requirements of this paragraph (b)(2) with respect to a claim, the 
claimant is deemed to have exhausted the internal claims and appeals 
process of this paragraph (b), except as provided in paragraph 
(b)(2)(ii)(F)(2) of this section. Accordingly, the claimant may initiate 
an external review under paragraph (c) or (d) of this section, as 
applicable. The claimant is also entitled to pursue any available 
remedies under section 502(a) of ERISA or under State law, as 
applicable, on the basis that the plan or issuer has failed to provide a 
reasonable internal claims and appeals process that would yield a 
decision on the merits of the claim. If a claimant chooses to pursue 
remedies under section 502(a) of ERISA under such circumstances, the 
claim or appeal is deemed denied on review without the exercise of 
discretion by an appropriate fiduciary.
    (2) Notwithstanding paragraph (b)(2)(ii)(F)(1) of this section, the 
internal claims and appeals process of this paragraph (b) will not be 
deemed exhausted based on de minimis violations that do not cause, and 
are not likely to cause, prejudice or harm to the claimant so long as 
the plan or issuer demonstrates that the violation was for good cause or 
due to matters beyond the control of the plan or issuer and that the 
violation occurred in the context of an ongoing, good faith exchange of 
information between the plan and the claimant. This exception is not 
available if the violation is part of a pattern or practice of 
violations by the plan or issuer. The claimant may request a written 
explanation of the violation from the plan or issuer, and the plan or 
issuer must provide such explanation within 10 days, including a 
specific description of its bases, if any, for asserting that the 
violation should not cause the internal claims and appeals process of 
this paragraph (b) to be deemed exhausted. If an external reviewer or a 
court rejects the claimant's request for immediate review under 
paragraph (b)(2)(ii)(F)(1) of this section on the basis that the plan 
met the standards for the exception under this paragraph 
(b)(2)(ii)(F)(2), the claimant has the right to resubmit and pursue the 
internal appeal of the claim. In such a case, within a reasonable time 
after the external reviewer or court rejects the claim for immediate 
review (not to exceed 10 days), the plan shall provide the claimant with 
notice of the opportunity to resubmit and pursue the internal appeal of 
the claim. Time periods for re-filing the claim shall begin to run upon 
claimant's receipt of such notice.
    (iii) Requirement to provide continued coverage pending the outcome 
of an appeal. A plan and issuer subject to the requirements of this 
paragraph (b)(2) are required to provide continued coverage pending the 
outcome of an appeal. For this purpose, the plan and issuer must comply 
with the requirements of 29 CFR 2560.503-1(f)(2)(ii), which generally 
provides that benefits for an ongoing course of treatment cannot be 
reduced or terminated without providing advance notice and an 
opportunity for advance review.
    (c) State standards for external review--(1) In general. (i) If a 
State external review process that applies to and is binding on a health 
insurance issuer offering group health insurance coverage includes at a 
minimum the consumer protections in the NAIC Uniform Model Act, then the 
issuer must comply with the applicable State external review process and 
is not required to comply

[[Page 501]]

with the Federal external review process of paragraph (d) of this 
section. In such a case, to the extent that benefits under a group 
health plan are provided through health insurance coverage, the group 
health plan is not required to comply with either this paragraph (c) or 
the Federal external review process of paragraph (d) of this section.
    (ii) To the extent that a group health plan provides benefits other 
than through health insurance coverage (that is, the plan is self-
insured) and is subject to a State external review process that applies 
to and is binding on the plan (for example, is not preempted by ERISA) 
and the State external review process includes at a minimum the consumer 
protections in the NAIC Uniform Model Act, then the plan must comply 
with the applicable State external review process and is not required to 
comply with the Federal external review process of paragraph (d) of this 
section.
    (iii) If a plan or issuer is not required under paragraph (c)(1)(i) 
or (c)(1)(ii) of this section to comply with the requirements of this 
paragraph (c), then the plan or issuer must comply with the Federal 
external review process of paragraph (d) of this section, except to the 
extent, in the case of a plan, the plan is not required under paragraph 
(c)(1)(i) of this section to comply with paragraph (d) of this section.
    (2) Minimum standards for State external review processes. An 
applicable State external review process must meet all the minimum 
consumer protections in this paragraph (c)(2). The Department of Health 
and Human Services will determine whether State external review 
processes meet these requirements.
    (i) The State process must provide for the external review of 
adverse benefit determinations (including final internal adverse benefit 
determinations) by issuers (or, if applicable, plans) that are based on 
the issuer's (or plan's) requirements for medical necessity, 
appropriateness, health care setting, level of care, or effectiveness of 
a covered benefit.
    (ii) The State process must require issuers (or, if applicable, 
plans) to provide effective written notice to claimants of their rights 
in connection with an external review for an adverse benefit 
determination.
    (iii) To the extent the State process requires exhaustion of an 
internal claims and appeals process, exhaustion must be unnecessary 
where the issuer (or, if applicable, the plan) has waived the 
requirement, the issuer (or the plan) is considered to have exhausted 
the internal claims and appeals process under applicable law (including 
by failing to comply with any of the requirements for the internal 
appeal process, as outlined in paragraph (b)(2) of this section), or the 
claimant has applied for expedited external review at the same time as 
applying for an expedited internal appeal.
    (iv) The State process provides that the issuer (or, if applicable, 
the plan) against which a request for external review is filed must pay 
the cost of the IRO for conducting the external review. Notwithstanding 
this requirement, the State external review process may require a 
nominal filing fee from the claimant requesting an external review. For 
this purpose, to be considered nominal, a filing fee must not exceed 
$25, it must be refunded to the claimant if the adverse benefit 
determination (or final internal adverse benefit determination) is 
reversed through external review, it must be waived if payment of the 
fee would impose an undue financial hardship, and the annual limit on 
filing fees for any claimant within a single plan year must not exceed 
$75.
    (v) The State process may not impose a restriction on the minimum 
dollar amount of a claim for it to be eligible for external review. 
Thus, the process may not impose, for example, a $500 minimum claims 
threshold.
    (vi) The State process must allow at least four months after the 
receipt of a notice of an adverse benefit determination or final 
internal adverse benefit determination for a request for an external 
review to be filed.
    (vii) The State process must provide that IROs will be assigned on a 
random basis or another method of assignment that assures the 
independence and impartiality of the assignment process (such as 
rotational assignment) by a State or independent entity, and in no

[[Page 502]]

event selected by the issuer, plan, or the individual.
    (viii) The State process must provide for maintenance of a list of 
approved IROs qualified to conduct the external review based on the 
nature of the health care service that is the subject of the review. The 
State process must provide for approval only of IROs that are accredited 
by a nationally recognized private accrediting organization.
    (ix) The State process must provide that any approved IRO has no 
conflicts of interest that will influence its independence. Thus, the 
IRO may not own or control, or be owned or controlled by a health 
insurance issuer, a group health plan, the sponsor of a group health 
plan, a trade association of plans or issuers, or a trade association of 
health care providers. The State process must further provide that the 
IRO and the clinical reviewer assigned to conduct an external review may 
not have a material professional, familial, or financial conflict of 
interest with the issuer or plan that is the subject of the external 
review; the claimant (and any related parties to the claimant) whose 
treatment is the subject of the external review; any officer, director, 
or management employee of the issuer; the plan administrator, plan 
fiduciaries, or plan employees; the health care provider, the health 
care provider's group, or practice association recommending the 
treatment that is subject to the external review; the facility at which 
the recommended treatment would be provided; or the developer or 
manufacturer of the principal drug, device, procedure, or other therapy 
being recommended.
    (x) The State process allows the claimant at least five business 
days to submit to the IRO in writing additional information that the IRO 
must consider when conducting the external review and it requires that 
the claimant is notified of the right to do so. The process must also 
require that any additional information submitted by the claimant to the 
IRO must be forwarded to the issuer (or, if applicable, the plan) within 
one business day of receipt by the IRO.
    (xi) The State process must provide that the decision is binding on 
the plan or issuer, as well as the claimant, except to the extent other 
remedies are available under State or Federal law, and except that the 
requirement that the decision be binding shall not preclude the plan or 
issuer from making payment on the claim or otherwise providing benefits 
at any time, including after a final external review decision that 
denies the claim or otherwise fails to require such payment or benefits. 
For this purpose, the plan or issuer must provide benefits (including by 
making payment on the claim) pursuant to the final external review 
decision without delay, regardless of whether the plan or issuer intends 
to seek judicial review of the external review decision and unless or 
until there is a judicial decision otherwise.
    (xii) The State process must require, for standard external review, 
that the IRO provide written notice to the claimant and the issuer (or, 
if applicable, the plan) of its decision to uphold or reverse the 
adverse benefit determination (or final internal adverse benefit 
determination) within no more than 45 days after the receipt of the 
request for external review by the IRO.
    (xiii) The State process must provide for an expedited external 
review if the adverse benefit determination (or final internal adverse 
benefit determination) concerns an admission, availability of care, 
continued stay, or health care service for which the claimant received 
emergency services, but has not been discharged from a facility; or 
involves a medical condition for which the standard external review time 
frame would seriously jeopardize the life or health of the claimant or 
jeopardize the claimant's ability to regain maximum function. As 
expeditiously as possible but within no more than 72 hours after the 
receipt of the request for expedited external review by the IRO, the IRO 
must make its decision to uphold or reverse the adverse benefit 
determination (or final internal adverse benefit determination) and 
notify the claimant and the issuer (or, if applicable, the plan) of the 
determination. If the notice is not in writing, the IRO must provide 
written confirmation of the decision within 48 hours after the date of 
the notice of the decision.

[[Page 503]]

    (xiv) The State process must require that issuers (or, if 
applicable, plans) include a description of the external review process 
in or attached to the summary plan description, policy, certificate, 
membership booklet, outline of coverage, or other evidence of coverage 
it provides to participants, beneficiaries, or enrollees, substantially 
similar to what is set forth in section 17 of the NAIC Uniform Model 
Act.
    (xv) The State process must require that IROs maintain written 
records and make them available upon request to the State, substantially 
similar to what is set forth in section 15 of the NAIC Uniform Model 
Act.
    (xvi) The State process follows procedures for external review of 
adverse benefit determinations (or final internal adverse benefit 
determinations) involving experimental or investigational treatment, 
substantially similar to what is set forth in section 10 of the NAIC 
Uniform Model Act.
    (3) Transition period for external review processes. (i) Through 
December 31, 2011, an applicable State external review process 
applicable to a health insurance issuer or group health plan is 
considered to meet the requirements of PHS Act section 2719(b). 
Accordingly, through December 31, 2011, an applicable State external 
review process will be considered binding on the issuer or plan (in lieu 
of the requirements of the Federal external review process). If there is 
no applicable State external review process, the issuer or plan is 
required to comply with the requirements of the Federal external review 
process in paragraph (d) of this section.
    (ii) For final internal adverse benefit determinations (or, in the 
case of simultaneous internal appeal and external review, adverse 
benefit determinations) provided on or after January 1, 2012, the 
Federal external review process will apply unless the Department of 
Health and Human Services determines that a State law meets all the 
minimum standards of paragraph (c)(2) of this section.
    (d) Federal external review process. A plan or issuer not subject to 
an applicable State external review process under paragraph (c) of this 
section must provide an effective Federal external review process in 
accordance with this paragraph (d) (except to the extent, in the case of 
a plan, the plan is described in paragraph (c)(1)(i) of this section as 
not having to comply with this paragraph (d)). In the case of health 
insurance coverage offered in connection with a group health plan, if 
either the plan or the issuer complies with the Federal external review 
process of this paragraph (d), then the obligation to comply with this 
paragraph (d) is satisfied for both the plan and the issuer with respect 
to the health insurance coverage.
    (1) Scope--(i) In general. Subject to the suspension provision in 
paragraph (d)(1)(ii) of this section and except to the extent provided 
otherwise by the Secretary in guidance, the Federal external review 
process established pursuant to this paragraph (d) applies to any 
adverse benefit determination or final internal adverse benefit 
determination (as defined in paragraphs (a)(2)(i) and (a)(2)(v) of this 
section), except that a denial, reduction, termination, or a failure to 
provide payment for a benefit based on a determination that a 
participant or beneficiary fails to meet the requirements for 
eligibility under the terms of a group health plan is not eligible for 
the Federal external review process under this paragraph (d).
    (ii) Suspension of general rule. Unless or until this suspension is 
revoked in guidance by the Secretary, with respect to claims for which 
external review has not been initiated before September 20, 2011, the 
Federal external review process established pursuant to this paragraph 
(d) applies only to:
    (A) An adverse benefit determination (including a final internal 
adverse benefit determination) by a plan or issuer that involves medical 
judgment (including, but not limited to, those based on the plan's or 
issuer's requirements for medical necessity, appropriateness, health 
care setting, level of care, or effectiveness of a covered benefit; or 
its determination that a treatment is experimental or investigational), 
as determined by the external reviewer; and
    (B) A rescission of coverage (whether or not the rescission has any 
effect on any particular benefit at that time).

[[Page 504]]

    (iii) Examples. The rules of paragraph (d)(1)(ii) of this section 
are illustrated by the following examples:

    Example 1. (i) Facts. A group health plan provides coverage for 30 
physical therapy visits generally. After the 30th visit, coverage is 
provided only if the service is preauthorized pursuant to an approved 
treatment plan that takes into account medical necessity using the 
plan's definition of the term. Individual A seeks coverage for a 31st 
physical therapy visit. A's health care provider submits a treatment 
plan for approval, but it is not approved by the plan, so coverage for 
the 31st visit is not preauthorized. With respect to the 31st visit, A 
receives a notice of final internal adverse benefit determination 
stating that the maximum visit limit is exceeded.
    (ii) Conclusion. In this Example 1, the plan's denial of benefits is 
based on medical necessity and involves medical judgment. Accordingly, 
the claim is eligible for external review during the suspension period 
under paragraph (d)(1)(ii) of this section. Moreover, the plan's 
notification of final internal adverse benefit determination is 
inadequate under paragraphs (b)(2)(i) and (b)(2)(ii)(E)(3) of this 
section because it fails to make clear that the plan will pay for more 
than 30 visits if the service is preauthorized pursuant to an approved 
treatment plan that takes into account medical necessity using the 
plan's definition of the term. Accordingly, the notice of final internal 
adverse benefit determination should refer to the plan provision 
governing the 31st visit and should describe the plan's standard for 
medical necessity, as well as how the treatment fails to meet the plan's 
standard.
    Example 2. (i) Facts. A group health plan does not provide coverage 
for services provided out of network, unless the service cannot 
effectively be provided in network. Individual B seeks coverage for a 
specialized medical procedure from an out-of-network provider because B 
believes that the procedure cannot be effectively provided in network. B 
receives a notice of final internal adverse benefit determination 
stating that the claim is denied because the provider is out-of-network.
    (ii) Conclusion. In this Example 2, the plan's denial of benefits is 
based on whether a service can effectively be provided in network and, 
therefore, involves medical judgment. Accordingly, the claim is eligible 
for external review during the suspension period under paragraph 
(d)(1)(ii) of this section. Moreover, the plan's notice of final 
internal adverse benefit determination is inadequate under paragraphs 
(b)(2)(i) and (b)(2)(ii)(E)(3) of this section because the plan does 
provide benefits for services on an out-of-network basis if the services 
cannot effectively be provided in network. Accordingly, the notice of 
final internal adverse benefit determination is required to refer to the 
exception to the out-of-network exclusion and should describe the plan's 
standards for determining effectiveness of services, as well as how 
services available to the claimant within the plan's network meet the 
plan's standard for effectiveness of services.

    (2) External review process standards. The Federal external review 
process established pursuant to this paragraph (d) will be similar to 
the process set forth in the NAIC Uniform Model Act and will meet 
standards issued by the Secretary. These standards will comply with all 
of the requirements described in this paragraph (d)(2).
    (i) These standards will describe how a claimant initiates an 
external review, procedures for preliminary reviews to determine whether 
a claim is eligible for external review, minimum qualifications for 
IROs, a process for approving IROs eligible to be assigned to conduct 
external reviews, a process for random assignment of external reviews to 
approved IROs, standards for IRO decision-making, and rules for 
providing notice of a final external review decision.
    (ii) These standards will provide an expedited external review 
process for--
    (A) An adverse benefit determination, if the adverse benefit 
determination involves a medical condition of the claimant for which the 
timeframe for completion of an expedited internal appeal under paragraph 
(b) of this section would seriously jeopardize the life or health of the 
claimant, or would jeopardize the claimant's ability to regain maximum 
function and the claimant has filed a request for an expedited internal 
appeal under paragraph (b) of this section; or
    (B) A final internal adverse benefit determination, if the claimant 
has a medical condition where the timeframe for completion of a standard 
external review pursuant to paragraph (d)(3) of this section would 
seriously jeopardize the life or health of the claimant or would 
jeopardize the claimant's ability to regain maximum function, or if the 
final internal adverse benefit determination concerns an admission, 
availability of care, continued stay, or health care service for which 
the claimant received emergency services, but has not been discharged 
from a facility.

[[Page 505]]

    (iii) With respect to claims involving experimental or 
investigational treatments, these standards will also provide additional 
consumer protections to ensure that adequate clinical and scientific 
experience and protocols are taken into account as part of the external 
review process.
    (iv) These standards will provide that an external review decision 
is binding on the plan or issuer, as well as the claimant, except to the 
extent other remedies are available under State or Federal law, and 
except that the requirement that the decision be binding shall not 
preclude the plan or issuer from making payment on the claim or 
otherwise providing benefits at any time, including after a final 
external review decision that denies the claim or otherwise fails to 
require such payment or benefits. For this purpose, the plan or issuer 
must provide any benefits (including by making payment on the claim) 
pursuant to the final external review decision without delay, regardless 
of whether the plan or issuer intends to seek judicial review of the 
external review decision and unless or until there is a judicial 
decision otherwise.
    (v) These standards may establish external review reporting 
requirements for IROs.
    (vi) These standards will establish additional notice requirements 
for plans and issuers regarding disclosures to participants and 
beneficiaries describing the Federal external review procedures 
(including the right to file a request for an external review of an 
adverse benefit determination or a final internal adverse benefit 
determination in the summary plan description, policy, certificate, 
membership booklet, outline of coverage, or other evidence of coverage 
it provides to participants or beneficiaries).
    (vii) These standards will require plans and issuers to provide 
information relevant to the processing of the external review, 
including, but not limited to, the information considered and relied on 
in making the adverse benefit determination or final internal adverse 
benefit determination.
    (e) Form and manner of notice--(1) In general. For purposes of this 
section, a group health plan and a health insurance issuer offering 
group health insurance coverage are considered to provide relevant 
notices in a culturally and linguistically appropriate manner if the 
plan or issuer meets all the requirements of paragraph (e)(2) of this 
section with respect to the applicable non-English languages described 
in paragraph (e)(3) of this section.
    (2) Requirements--(i) The plan or issuer must provide oral language 
services (such as a telephone customer assistance hotline) that include 
answering questions in any applicable non-English language and providing 
assistance with filing claims and appeals (including external review) in 
any applicable non-English language;
    (ii) The plan or issuer must provide, upon request, a notice in any 
applicable non-English language; and
    (iii) The plan or issuer must include in the English versions of all 
notices, a statement prominently displayed in any applicable non-English 
language clearly indicating how to access the language services provided 
by the plan or issuer.
    (3) Applicable non-English language. With respect to an address in 
any United States county to which a notice is sent, a non-English 
language is an applicable non-English language if ten percent or more of 
the population residing in the county is literate only in the same non-
English language, as determined in guidance published by the Secretary.
    (f) Secretarial authority. The Secretary may determine that the 
external review process of a group health plan or health insurance 
issuer, in operation as of March 23, 2010, is considered in compliance 
with the applicable process established under paragraph (c) or (d) of 
this section if it substantially meets the requirements of paragraph (c) 
or (d) of this section, as applicable.
    (g) Applicability/effective date. The provisions of this section 
apply for plan years beginning on or after September 23, 2010. See Sec. 
54.9815-1251T for determining the application of this section to 
grandfathered health plans (providing that these rules regarding 
internal claims and appeals and external review processes do not apply 
to grandfathered health plans).

[[Page 506]]

    (h) Expiration date. The applicability of this section expires on 
July 22, 2013 or on such earlier date as may be provided in final 
regulations or other action published in the Federal Register.

[T.D. 9494, 75 FR 43350, July 23, 2010, as amended by T.D. 9532, 76 FR 
37228, June 24, 2011]



Sec. 54.9831-1  Special rules relating to group health plans.

    (a) Group health plan--(1) Defined. A group health plan means a plan 
(including a self-insured plan) of, or contributed to by, an employer 
(including a self-employed person) or employee organization to provide 
health care (directly or otherwise) to the employees, former employees, 
the employer, others associated or formerly associated with the employer 
in a business relationship, or their families.
    (2) Determination of number of plans. [Reserved]
    (b) General exception for certain small group health plans. (1) 
Subject to paragraph (b)(2) of this section, the requirements of 
Sec. Sec. 54.9801-1 through 54.9801-6, 54.9802-1, 54.9802-2, 54.9811-1, 
54.9812-1T, and 54.9833-1 do not apply to any group health plan for any 
plan year if, on the first day of the plan year, the plan has fewer than 
two participants who are current employees.
    (2) The exception of paragraph (b)(1) of this section does not apply 
with respect to the following requirements:
    (i) Section 54.9801-3(b)(6).
    (ii) Section 54.9802-1(b), as such paragraph applies with respect to 
genetic information as a health factor.
    (iii) Section 54.9802-1(c), as such paragraph applies with respect 
to genetic information as a health factor.
    (iv) Section 54.9802-1(e), as such paragraph applies with respect to 
genetic information as a health factor.
    (v) Section 54.9802-3T(b).
    (vi) Section 54.9802-3T(c).
    (vii) Section 54.9802-3T(d).
    (viii) Section 54.9802-3T(e).
    (c) Excepted benefits--(1) In general. The requirements of 
Sec. Sec. 54.9801-1 through 54.9801-6, 54.9802-1, 54.9802-2, 54.9811-
1T, 54.9812-1T, and 54.9833-1 do not apply to any group health plan in 
relation to its provision of the benefits described in paragraph (c)(2), 
(3), (4), or (5) of this section (or any combination of these benefits).
    (2) Benefits excepted in all circumstances. The following benefits 
are excepted in all circumstances--
    (i) Coverage only for accident (including accidental death and 
dismemberment);
    (ii) Disability income coverage;
    (iii) Liability insurance, including general liability insurance and 
automobile liability insurance;
    (iv) Coverage issued as a supplement to liability insurance;
    (v) Workers' compensation or similar coverage;
    (vi) Automobile medical payment insurance;
    (vii) Credit-only insurance (for example, mortgage insurance); and
    (viii) Coverage for on-site medical clinics.
    (3) Limited excepted benefits--(i) In general. Limited-scope dental 
benefits, limited-scope vision benefits, or long-term care benefits are 
excepted if they are provided under a separate policy, certificate, or 
contract of insurance, or are otherwise not an integral part of a group 
health plan as described in paragraph (c)(3)(ii) of this section. In 
addition, benefits provided under a health flexible spending arrangement 
are excepted benefits if they satisfy the requirements of paragraph 
(c)(3)(v) of this section.
    (ii) Not an integral part of a group health plan. For purposes of 
this paragraph (c)(3), benefits are not an integral part of a group 
health plan (whether the benefits are provided through the same plan or 
a separate plan) only if the following two requirements are satisfied--
    (A) Participants must have the right to elect not to receive 
coverage for the benefits; and
    (B) If a participant elects to receive coverage for the benefits, 
the participant must pay an additional premium or contribution for that 
coverage.
    (iii) Limited scope--(A) Dental benefits. Limited scope dental 
benefits are benefits substantially all of which are for treatment of 
the mouth (including any organ or structure within the mouth).
    (B) Vision benefits. Limited scope vision benefits are benefits 
substantially

[[Page 507]]

all of which are for treatment of the eye.
    (iv) Long-term care. Long-term care benefits are benefits that are 
either--
    (A) Subject to State long-term care insurance laws;
    (B) For qualified long-term care services, as defined in section 
7702B(c)(1), or provided under a qualified long-term care insurance 
contract, as defined in section 7702B(b); or
    (C) Based on cognitive impairment or a loss of functional capacity 
that is expected to be chronic.
    (v) Health flexible spending arrangements. Benefits provided under a 
health flexible spending arrangement (as defined in section 106(c)(2)) 
are excepted for a class of participants only if they satisfy the 
following two requirements--
    (A) Other group health plan coverage, not limited to excepted 
benefits, is made available for the year to the class of participants by 
reason of their employment; and
    (B) The arrangement is structured so that the maximum benefit 
payable to any participant in the class for a year cannot exceed two 
times the participant's salary reduction election under the arrangement 
for the year (or, if greater, cannot exceed $500 plus the amount of the 
participant's salary reduction election). For this purpose, any amount 
that an employee can elect to receive as taxable income but elects to 
apply to the health flexible spending arrangement is considered a salary 
reduction election (regardless of whether the amount is characterized as 
salary or as a credit under the arrangement).
    (4) Noncoordinated benefits--(i) Excepted benefits that are not 
coordinated. Coverage for only a specified disease or illness (for 
example, cancer-only policies) or hospital indemnity or other fixed 
indemnity insurance is excepted only if it meets each of the conditions 
specified in paragraph (c)(4)(ii) of this section. To be hospital 
indemnity or other fixed indemnity insurance, the insurance must pay a 
fixed dollar amount per day (or per other period) of hospitalization or 
illness (for example, $100/day) regardless of the amount of expenses 
incurred.
    (ii) Conditions. Benefits are described in paragraph (c)(4)(i) of 
this section only if--
    (A) The benefits are provided under a separate policy, certificate, 
or contract of insurance;
    (B) There is no coordination between the provision of the benefits 
and an exclusion of benefits under any group health plan maintained by 
the same plan sponsor; and
    (C) The benefits are paid with respect to an event without regard to 
whether benefits are provided with respect to the event under any group 
health plan maintained by the same plan sponsor.
    (iii) Example. The rules of this paragraph (c)(4) are illustrated by 
the following example:

    Example. (i) Facts. An employer sponsors a group health plan that 
provides coverage through an insurance policy. The policy provides 
benefits only for hospital stays at a fixed percentage of hospital 
expenses up to a maximum of $100 a day.
    (ii) Conclusion. In this Example, even though the benefits under the 
policy satisfy the conditions in paragraph (c)(4)(ii) of this section, 
because the policy pays a percentage of expenses incurred rather than a 
fixed dollar amount, the benefits under the policy are not excepted 
benefits under this paragraph (c)(4). This is the result even if, in 
practice, the policy pays the maximum of $100 for every day of 
hospitalization.

    (5) Supplemental benefits. (i) The following benefits are excepted 
only if they are provided under a separate policy, certificate, or 
contract of insurance--
    (A) Medicare supplemental health insurance (as defined under section 
1882(g)(1) of the Social Security Act; also known as Medigap or MedSupp 
insurance);
    (B) Coverage supplemental to the coverage provided under Chapter 55, 
Title 10 of the United States Code (also known as TRICARE supplemental 
programs); and
    (C) Similar supplemental coverage provided to coverage under a group 
health plan. To be similar supplemental coverage, the coverage must be 
specifically designed to fill gaps in primary coverage, such as 
coinsurance or deductibles. Similar supplemental coverage does not 
include coverage that becomes secondary or supplemental

[[Page 508]]

only under a coordination-of-benefits provision.
    (ii) The rules of this paragraph (c)(5) are illustrated by the 
following example:

    Example. (i) Facts. An employer sponsors a group health plan that 
provides coverage for both active employees and retirees. The coverage 
for retirees supplements benefits provided by Medicare, but does not 
meet the requirements for a supplemental policy under section 1882(g)(1) 
of the Social Security Act.
    (ii) Conclusion. In this Example, the coverage provided to retirees 
does not meet the definition of supplemental excepted benefits under 
this paragraph (c)(5) because the coverage is not Medicare supplemental 
insurance as defined under section 1882(g)(1) of the Social Security 
Act, is not a TRICARE supplemental program, and is not supplemental to 
coverage provided under a group health plan.

    (d) Treatment of partnerships. For purposes of this part:
    (1) Treatment as a group health plan. (See 29 CFR 2590.732(d)(1) and 
45 CFR 146.145(d)(1), under which a plan providing medical care, 
maintained by a partnership, and usually not treated as an employee 
welfare benefit plan under ERISA is treated as a group health plan for 
purposes of Part 7 of Subtitle B of Title I of ERISA and Title XXVII of 
the PHS Act.)
    (2) Employment relationship. In the case of a group health plan, the 
term employer also includes the partnership in relation to any bona fide 
partner. In addition, the term employee also includes any bona fide 
partner. Whether or not an individual is a bona fide partner is 
determined based on all the relevant facts and circumstances, including 
whether the individual performs services on behalf of the partnership.
    (3) Participants of group health plans. In the case of a group 
health plan, the term participant also includes any individual described 
in paragraph (d)(3)(i) or (ii) of this section if the individual is, or 
may become, eligible to receive a benefit under the plan or the 
individual's beneficiaries may be eligible to receive any such benefit.
    (i) In connection with a group health plan maintained by a 
partnership, the individual is a partner in relation to the partnership.
    (ii) In connection with a group health plan maintained by a self-
employed individual (under which one or more employees are 
participants), the individual is the self-employed individual.
    (e) Determining the average number of employees. [Reserved]

[T.D. 9166, 69 FR 78746, Dec. 30, 2004; 70 FR 21146, Apr. 25, 2005, as 
amended by T.D. 9299, 71 FR 75057, Dec. 13, 2006; T.D. 9427, 73 FR 
62422, Oct. 20, 2008; T.D. 9464, 74 FR 51678, Oct. 7, 2009]



Sec. 54.9833-1  Effective dates.

    Sections 54.9801-1 through 54.9801-6, 54.9831-1, and this section 
are applicable for plan years beginning on or after July 1, 2005.

[T.D. 9166, 69 FR 78746, Dec. 30, 2004]



PART 55_EXCISE TAX ON REAL ESTATE INVESTMENT TRUSTS AND REGULATED 
INVESTMENT COMPANIES--Table of Contents



          Subpart A_Excise Tax on Real Estate Investment Trusts

Sec.
55.4981-1 Imposition of excise tax on certain real estate investment 
          trust taxable income not distributed during the taxable year; 
          taxable years ending on or before January 1, 1987.
55.4981-2 Imposition of excise tax with respect to certain undistributed 
          income of real estate investment trusts; calendar years 
          beginning after December 31, 1986.

         Subpart B_Excise Tax on Regulated Investment Companies

55.4982-1 Imposition of excise tax on undistributed income of regulated 
          investment companies.

                 Subpart C_Procedure and Administration

55.6001-1 Notice or regulations requiring records, statements, and 
          special returns.
55.6011-1 General requirement of return, statement, or list.
55.6060-1 Reporting requirements for tax return preparers.
55.6061-1 Signing of returns and other documents.
55.6065-1 Verification of returns.
55.6071-1 Time for filing returns.
55.6081-1 Automatic extension of time for filing a return due under 
          Chapter 44.
55.6091-1 Place for filing Chapter 44 tax returns.
55.6091-2 Exceptional cases.

[[Page 509]]

55.6107-1 Tax return preparer must furnish copy of return or claim for 
          refund to taxpayer and must retain a copy or record.
55.6109-1 Tax return preparers furnishing identifying numbers for 
          returns or claims for refund.
55.6151-1 Time and place for paying of tax shown on returns.
55.6161-1 Extension of time for paying tax or deficiency.
55.6165-1 Bonds where time to pay tax or deficiency has been extended.
55.6694-1 Section 6694 penalties applicable to tax return preparer.
55.6694-2 Penalties for understatement due to an unreasonable position.
55.6694-3 Penalty for understatement due to willful, reckless, or 
          intentional conduct.
55.6694-4 Extension of period of collection when tax return preparer 
          pays 15 percent of a penalty for understatement of taxpayer's 
          liability and certain other procedural matters.
55.6695-1 Other assessable penalties with respect to the preparation of 
          tax returns or claims for refund for other persons.
55.6696-1 Claims for credit or refund by tax return preparers.
55.7701-1 Tax return preparer.

    Authority: 26 U.S.C. 6001, 6011, 6071, 6091, and 7805.
    Section 55.4981-1 also issued under sec. 860(e), 92 Stat. 2849 (26 
U.S.C. 860(e); sec. 860(g), 92 Stat. 2850 (26 U.S.C. 860(g)); and sec 
7805. 68A Stat. 917 (26 U.S.C. 7805) of the Internal Revenue Code of 
1954), 26 U.S.C. 7805;
    Section 55.6011-1 also issued under 26 U.S.C. 6011(a);
    Section 55.6060-1 also issued under 26 U.S.C. 6060(a);
    Section 55.6071-1 also issued under 26 U.S.C. 6071(a);
    Section 55.6081-1 also issued under 26 U.S.C. 6081(a);
    Section 55.6091-1 also issued under 26 U.S.C. 6091(a);
    Section 55.6109-1 also issued under 26 U.S.C. 6109(a);
    Section 55.6109-2 also issued under 26 U.S.C. 6109(a);
    Section 55.6151-1 also issued under 26 U.S.C. 6151;
    Section 55.6695-1 also issued under 26 U.S.C. 6695(b).

    Source: T.D. 7767, 46 FR 11282, Feb. 6, 1981; 46 FR 15263, Mar. 5, 
1981, unless otherwise noted.



          Subpart A_Excise Tax on Real Estate Investment Trusts



Sec. 55.4981-1  Imposition of excise tax on certain real estate 
investment trust taxable income not distributed during the taxable year;

taxable years ending on or before January 1, 1987.

    Section 4981 as in effect before amendment by the Tax Reform Act of 
1986 imposes an excise tax on a real estate investment trust if the 
deduction for dividends paid for the taxable year does not equal at 
least 75 percent of its real estate investment trust taxable income 
(computed as provided in section 4981 as in effect before amendment by 
the Tax Reform Act of 1986) for the taxable year. For purposes of 
section 4981 as in effect before amendment by the Tax Reform Act of 
1986, the deduction for dividends paid is computed without regard to 
capital gains dividends (as defined in section 857(b)(3)(C)) and without 
regard to any dividends actually paid after the close of the taxable 
year. Thus, dividends considered as paid during the taxable year under 
section 858 are disregarded. Deficiency dividends (as defined in section 
860(f) paid with respect to the taxable year are also disregarded. The 
return referred to in the last sentence of section 4981 as in effect 
before amendment by the Tax Reform Act of 1986 in the income tax return. 
Section 4981 as in effect before amendment by the Tax Reform Act of 
1986, applies only to taxable years beginning after December 31, 1979 
and ending before January 1, 1987, for which the taxpayer is taxable 
under Part II of Subchapter M of Chapter 1 of subtitle A as a real 
estate investment trust.

[T.D. 7767, 46 FR 11282, Feb. 6, 1981; 46 FR 15263, Mar. 5, 1981; T.D. 
7936, 49 FR 2109, Jan. 18, 1984; T.D. 8180, 53 FR 6147, Mar. 1, 1988]



Sec. 55.4981-2  Imposition of excise tax with respect to certain 
undistributed income of real estate investment trusts; calendar years 

beginning after December 31, 1986.

    Section 4981, as amended by the Tax Reform Act of 1986, imposes an 
excise tax on a real estate investment trust in

[[Page 510]]

the amount of four percent of the excess, if any, of the required 
distribution for a calendar year over the distributed amount for such 
calendar year. Section 4981, as so amended, applies only to calendar 
years that begin after December 31, 1986. For provisions relating to the 
imposition of an excise tax with respect to certain undistributed income 
of real estate investment trusts for taxable years ending before January 
1, 1987, see Sec. 55.4981-1.

[T.D. 8180, 53 FR 6148, Mar. 1, 1988]



         Subpart B_Excise Tax on Regulated Investment Companies



Sec. 55.4982-1  Imposition of excise tax on undistributed income of
regulated investment companies.

    Section 4982 imposes an excise tax on a regulated investment company 
in the amount of four percent of the excess, if any, of the required 
distribution for a calendar year over the distributed amount for such 
calendar year. Section 4982 applies only to calendar years beginning 
after December 31, 1986.

[T.D. 8180, 53 FR 6148, Mar. 1, 1988]



                 Subpart C_Procedure and Administration

    Source: T.D. 7767, 46 FR 11282, Feb. 6, 1981; 46 FR 15263, Mar. 5, 
1981, unless otherwise noted. Redesignated by T.D. 8180, 53 FR 6148, 
Mar. 1, 1988.



Sec. 55.6001-1  Notice or regulations requiring records, statements,
and special returns.

    (a) In general. Any person subject to tax under Chapter 44 of the 
Code shall keep such complete and detailed records as are sufficient to 
enable the district director to determine accurately the amount of 
liability under Chapter 44.
    (b) Notice by district director requiring returns, statements, or 
the keeping of records. The district director may require any person, by 
notice served upon him, to make such returns, render such statements, or 
keep such specific records as will enable the district director to 
determine whether or not such person is liable for tax under Chapter 44.
    (c) Retention of records. The records required by this section shall 
be kept at all times available for inspection by authorized internal 
revenue officers or employees, and shall be retained so long as the 
contents thereof may become material in the administration of any 
internal revenue law.



Sec. 55.6011-1  General requirement of return, statement, or list.

    Every person liable for tax under Chapter 44 shall file an annual 
return with respect to the tax on the form prescribed by the Internal 
Revenue Service for such purpose and shall include therein the 
information required by the form and the instructions issued with 
respect thereto. For calendar years beginning after December 31, 1986, 
the return, which must be made on a calendar year basis, shall be filed 
by a real estate investment trust on Form 8612 and by a regulated 
investment company on Form 8613.

[T.D. 8180, 53 FR 6148, Mar. 1, 1988]



Sec. 55.6060-1  Reporting requirements for tax return preparers.

    (a) In general. A person that employs one or more tax return 
preparers to prepare a return or claim for refund under chapter 44 of 
subtitle D of the Internal Revenue Code, other than for the person, at 
any time during a return period, shall satisfy the record keeping and 
inspection requirements in the manner stated in Sec. 1.6060-1 of this 
chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78459, Dec. 22, 2008]



Sec. 55.6061-1  Signing of returns and other documents.

    Any return required to be made by a real estate investment trust or 
a regulated investment company with respect to the tax imposed by 
Chapter 44 shall be signed by a person authorized by section 6062 of the 
Code to sign the income tax return of the real estate investment trust 
or the regulated investment company. Any statement or other document 
required to be made with respect to the tax imposed by

[[Page 511]]

Chapter 44 shall be signed by the person required or duly authorized to 
sign in accordance with the regulations, forms, or instructions 
prescribed with respect to such statement or document. An individual's 
signature on a return, statement, or other document made by or for the 
real estate investment trust or the regulated investment company shall 
be prima facie evidence that the individual is authorized to sign the 
return, statement, or other document.

[T.D. 8180, 53 FR 6148, Mar. 1, 1988]



Sec. 55.6065-1  Verification of returns.

    If a return, statement, or other document made under the provisions 
of Chapter 44 or Subtitle F or the Code or the regulations thereunder 
with respect to any tax imposed by Chapter 44 of the Code, or the form 
and instructions issued with respect to such return, statement, or other 
document, requires that it shall contain or be verified by a written 
declaration that it is made under the penalties of perjury, it must be 
so verified by the person or persons required to sign such return, 
statement, or other document. In addition, any other statement or 
document submitted under any provision of Chapter 44 or Subtitle F of 
the Code or regulations thereunder with respect to any tax imposed by 
Chapter 44 of the Code may be required to contain or be verified by a 
written declaration that it is made under the penalties of perjury.



Sec. 55.6071-1  Time for filing returns.

    (a) Returns for calendar years beginning after December 31, 1986. A 
return required by Sec. 55.6011-1 for any calendar year beginning after 
December 31, 1986, shall be filed on or before March 15 of the following 
calendar year. See Sec. 55.6081-1 for rules relating to extensions of 
time for filing a return required by Sec. 55.6011-1.
    (b) Returns for excise tax under section 4981 as in effect before 
amendment by the Tax Reform Act of 1986. A return required by Sec. 
55.6011-1 for any excise tax under section 4981, as in effect before 
amendment by the Tax Reform Act of 1986, shall be filed at the time 
(including any extension of time granted or allowed under section 6081) 
that the real estate investment trust is required to file its income tax 
return under section 6012 for the taxable year for which the tax under 
section 4981, as in effect before amendment by the Tax Reform Act of 
1986, is imposed.

[T.D. 8180, 53 FR 6148, Mar. 1, 1988]



Sec. 55.6081-1  Automatic extension of time for filing a return due 
under Chapter 44.

    (a) In general. A Real Estate Investment Trust (REIT) required to 
file a return on Form 8612, ``Return of Excise Tax on Undistributed 
Income of Real Estate Investment Trusts,'' or a Regulated Investment 
Company (RIC) required to file a return on Form 8613, ``Return of Excise 
Tax on Undistributed Income of Regulated Investment Companies,'' will be 
allowed an automatic 6-month extension of time to file the return after 
the date prescribed for filing the return if the REIT or RIC files an 
application under this section in accordance with paragraph (b) of this 
section.
    (b) Requirements. To satisfy this paragraph (b), a REIT or RIC 
must--
    (1) Submit a complete application on Form 7004, ``Application for 
Automatic Extension of Time to File Certain Business Income Tax, 
Information, and Other Returns,'' or in any other manner prescribed by 
the Commissioner;
    (2) File the application on or before the date prescribed for filing 
the return with the Internal Revenue Service office designated in the 
application's instructions; and
    (3) Remit the amount of the properly estimated unpaid tax liability 
on or before the date prescribed for payment.
    (c) No extension of time for the payment of tax. An automatic 
extension of time for filing a return granted under paragraph (a) of 
this section will not extend the time for payment of any tax due on such 
return.
    (d) Termination of automatic extension. The Commissioner may 
terminate an automatic extension at any time by mailing to the REIT or 
RIC a notice of termination at least 10 days prior to the termination 
date designated in such notice. The Commissioner must mail the notice of 
termination to the address shown on the Form 7004 or to the REIT or 
RIC's last known address.

[[Page 512]]

For further guidance regarding the definition of last known address, see 
Sec. 301.6212-2 of this chapter.
    (e) Penalties. See section 6651 for failure to file or failure to 
pay the amount shown as tax on the return.
    (f) Effective/applicable dates. This section is applicable for 
applications for an automatic extension of time to file a return due 
under chapter 44, filed after July 1, 2008.

[T.D. 9407, 73 FR 37369, July 1, 2008]



Sec. 55.6091-1  Place for filing Chapter 44 tax returns.

    Except as provided in Sec. 55.6091-2 (relating to exceptional 
cases):
    (a) In general. Chapter 44 tax returns shall be filed with any 
person assigned the responsibility to receive returns in the local 
Internal Revenue Service office serving the principal place of business 
or principal office or agency of the real estate investment trust or 
regulated investment company.
    (b) Returns filed with service centers or by hand carrying. 
Notwithstanding paragraph (a) of this section, unless a return is filed 
by hand carrying, whenever instructions applicable to Chapter 44 tax 
returns provide that the returns be filed with a service center, the 
returns must be so filed in accordance with the instructions. Returns 
which are filed by hand carrying shall be filed with any person assigned 
the responsibility to receive hand-carried returns in the local Internal 
Revenue Service office in accordance with paragraph (a) of this section.

[T.D. 7767, 46 FR 11282, Feb. 6, 1981; 46 FR 15263, Mar. 5, 1981. 
Redesignated and amended by T.D. 8180, 53 FR 6148, Mar. 1, 1988; T.D. 
9156, 69 FR 55746, Sept. 16, 2004]



Sec. 55.6091-2  Exceptional cases.

    Notwithstanding the provisions of Sec. 55.6091-1, the Commissioner 
may permit the filing of any Chapter 44 tax return in any local Internal 
Revenue Service office.

[T.D. 7767, 46 FR 11282, Feb. 6, 1981; 46 FR 15263, Mar. 5, 1981. 
Redesignated by T.D. 8180, 53 FR 6148, Mar. 1, 1988, as amended by T.D. 
9156, 69 FR 55746, Sept. 16, 2004]



Sec. 55.6107-1  Tax return preparer must furnish copy of return or claim
for refund to taxpayer and must retain a copy or record.

    (a) In general. A person who is a signing tax return preparer of any 
return or claim for refund of tax under Chapter 44 of subtitle D of the 
Internal Revenue Code shall furnish a completed copy of the return or 
claim for refund to the taxpayer, and retain a completed copy or record 
in the manner stated in Sec. 1.6107-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78459, Dec. 22, 2008]



Sec. 55.6109-1  Tax return preparers furnishing identifying numbers
for returns or claims for refund.

    (a) In general. Each tax return or claim for refund of tax under 
chapter 44 of Subtitle D prepared by one or more signing tax return 
preparers must include the identifying number of the preparer required 
by Sec. 1.6695-1(b) of this chapter to sign the return or claim for 
refund in the manner stated in Sec. 1.6109-2 of this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed after December 31, 
2008.

[T.D. 9436, 73 FR 78459, Dec. 22, 2008]



Sec. 55.6151-1  Time and place for paying of tax shown on returns.

    The tax shown on any return which is imposed by Chapter 44 shall, 
without notice or assessment and demand, be paid to the internal revenue 
officer with whom the return is filed at the time and place for filing 
such return (determined without regard to any extension of time for 
filing the return). For provisions relating to the time and place for 
filing such return, see Sec. Sec. 55.6071-1 and 55.6091-1. For 
provisions relating to the extension of time for paying the tax see 
Sec. 55.6161-1.

[T.D. 8180, 53 FR 6148, Mar. 1, 1988]

[[Page 513]]



Sec. 55.6161-1  Extension of time for paying tax or deficiency.

    (a) In general--(1) Tax shown or required to be shown on return. A 
reasonable extension of the time for payment of the amount of any tax 
imposed by Chapter 44 and shown or required to be shown on any return, 
may be granted by the district directors at the request of the taxpayer. 
The period of such extension shall not be in excess of 6 months from the 
date fixed for payment of such tax.
    (2) Deficiency. The time for payment of any amount determined as a 
deficiency in respect of tax imposed by Chapter 44 may, at the request 
of the taxpayer, be extended by the internal revenue officer to whom the 
tax is required to be paid. The extension may be for a period not to 
exceed 18 months from the date fixed for payment of the deficiency, as 
shown on the notice and demand. In exceptional cases, a further 
extension for a period not in excess of 12 months may be granted. No 
extension of time for payment of a deficiency shall be granted if the 
deficiency is due to negligence, to intentional disregard of rules and 
regulations, or to fraud with intent to evade tax.
    (3) Extension of time for filing distinguished. The granting of an 
extension of time for filing a return does not operate to extend the 
time for the payment of the tax or any part thereof unless so specified 
in the extension.
    (b) Certain rules relating to extension of time for paying income 
tax to apply. The provisions of Sec. 1.6161-1 (b), and (c), and (d) of 
this chapter (relating to a requirement for undue hardship, the 
application for extension, and payment pursuant to an extension) shall 
apply to extensions of time for payment of the tax imposed by Chapter 
44.



Sec. 55.6165-1  Bonds where time to pay tax or deficiency has been 
extended.

    If an extension of time for payment of tax or deficiency is granted 
under section 6161, the district director or the director of the service 
center may, if he deems it necessary, require a bond for the payment of 
the amount in respect of which the extension is granted in accordance 
with the terms of the extension. However, the bond shall not exceed 
double the amount with respect to which the extension is granted. For 
provisions relating to form of bonds, see the regulations under section 
7101 contained in part 301 of this chapter (Regulations on Procedure and 
Administration).



Sec. 55.6694-1  Section 6694 penalties applicable to tax return 
preparer.

    (a) In general. For general definitions regarding section 6694 
penalties applicable to preparers of tax returns or claims for refund of 
tax under chapter 44 of Subtitle D see Sec. 1.6694-1 of this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed, and advice provided, 
after December 31, 2008.

[T.D. 9436, 73 FR 78459, Dec. 22, 2008]



Sec. 55.6694-2  Penalties for understatement due to an unreasonable 
position.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of excise tax under chapter 44 of subtitle D of the 
Internal Revenue Code (Code) shall be subject to penalties under section 
6694(a) of the Code in the manner stated in Sec. 1.6694-2 of this 
chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78459, Dec. 22, 2008]



Sec. 55.6694-3  Penalty for understatement due to willful, reckless, 
or intentional conduct.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under chapter 44 of subtitle D of the 
Internal Revenue Code (Code) shall be subject to penalties under section 
6694(b) of the Code in the manner stated in Sec. 1.6694-3 of this 
chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78459, Dec. 22, 2008]

[[Page 514]]



Sec. 55.6694-4  Extension of period of collection when tax return 
preparer pays 15 percent of a penalty for understatement of taxpayer's

liability and certain other procedural matters.

    (a) In general. For rules relating to the extension of period of 
collection when a tax return preparer who prepared a return or claim for 
refund for excise tax under chapter 44 of subtitle D of the Internal 
Revenue Code pays 15 percent of a penalty for understatement of 
taxpayer's liability and procedural matters relating to the 
investigation, assessment and collection of the penalties under section 
6694(a) and (b), the rules under Sec. 1.6694-4 of this chapter will 
apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78460, Dec. 22, 2008]



Sec. 55.6695-1  Other assessable penalties with respect to the 
preparation of tax returns or claims for refund for other persons.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under chapter 44 of subtitle D of the 
Internal Revenue Code (Code) shall be subject to penalties for failure 
to furnish a copy to the taxpayer under section 6695(a) of the Code, 
failure to sign the return under section 6695(b) of the Code, failure to 
furnish an identification number under section 6695(c) of the Code, 
failure to retain a copy or list under section 6695(d) of the Code, 
failure to file a correct information return under section 6695(e) of 
the Code, and negotiation of a check under section 6695(f) of the Code, 
in the manner stated in Sec. 1.6695-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78460, Dec. 22, 2008]



Sec. 55.6696-1  Claims for credit or refund by tax return preparers.

    (a) In general. For rules for claims for credit or refund by a tax 
return preparer who prepared a return or claim for refund for tax under 
chapter 44 of subtitle D of the Internal Revenue Code, the rules under 
Sec. 1.6696-1 of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78460, Dec. 22, 2008]



Sec. 55.7701-1  Tax return preparer.

    (a) In general. For the definition of a tax return preparer, see 
Sec. 301.7701-15 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78460, Dec. 22, 2008]



PART 56_PUBLIC CHARITY EXCISE TAXES--Table of Contents



Sec.
56.4911-0 Outline of regulations under section 4911.
56.4911-1 Tax on excess lobbying expenditures.
56.4911-2 Lobbying expenditures, direct lobbying communications, and 
          grass roots lobbying communications.
56.4911-3 Expenditures for direct and/or grass roots lobbying 
          communications.
56.4911-4 Exempt purpose expenditures.
56.4911-5 Communications with members.
56.4911-6 Records of lobbying and grass roots expenditures.
56.4911-7 Affiliated group of organizations.
56.4911-8 Excess lobbying expenditures of affiliated group.
56.4911-9 Application of section 501(h) to affiliated groups of 
          organizations.
56.4911-10 Members of a limited affiliated group of organizations.
56.6001-1 Notice or regulations requiring records, statements, and 
          special returns.
56.6011-1 General requirement of return, statement, or list.
56.6011-4 Requirement of statement disclosing participation in certain 
          transactions by taxpayers.
56.6060-1 Reporting requirements for tax return preparers.
56.6107-1 Tax return preparer must furnish copy of return and claim for 
          refund to taxpayer and must retain a copy or record.
56.6109-1 Tax return preparers furnishing identifying numbers for 
          returns or claims for refund.
56.6694-1 Section 6694 penalties applicable to tax return preparer.
56.6694-2 Penalties for understatement due to an unreasonable position.

[[Page 515]]

56.6694-3 Penalty for understatement due to willful, reckless, or 
          intentional conduct.
56.6694-4 Extension of period of collection when tax return preparer 
          pays 15 percent of a penalty for understatement of taxpayer's 
          liability and certain other procedural matters.
56.6695-1 Other assessable penalties with respect to the preparation of 
          tax returns or claims for refund for other persons.
56.6696-1 Claims for credit or refund by tax return preparers.
56.7701-1 Tax return preparer.

    Authority: 26 U.S.C. 7805.
    Section 56.4911-7 also issued under 26 U.S.C. 4911(f)(3);
    Section 56.6060-1 also issued under 26 U.S.C. 6060(a);
    Section 56.6109-1 also issued under 26 U.S.C. 6109(a);
    Section 56.6109-2 also issued under 26 U.S.C. 6109(a);
    Section 56.6695-1 also issued under 26 U.S.C. 6695(b).

    Source: T.D. 8308, 55 FR 35598, Aug. 31, 1990, unless otherwise 
noted.



Sec. 56.4911-0  Outline of regulations under section 4911.

    Immediately following is an outline of the regulations under section 
4911 of the Internal Revenue Code relating to an excise tax on electing 
public charities' excess lobbying expenditures.

       Sec. 56.4911-0 Outline of regulations under section 4911.

          Sec. 56.4911-1 Tax on excess lobbying expenditures.

    (a) In general.
    (b) Excess lobbying expenditures.
    (c) Nontaxable amounts.
    (1) Lobbying nontaxable amount.
    (2) Grass roots nontaxable amount.
    (d) Examples.

 Sec. 56.4911-2 Lobbying expenditures, direct lobbying communications, 
                and grass roots lobbying communications.

    (a) Lobbying expenditures.
    (1) In general.
    (2) Overview of Sec. 56.4911 and the definitions of ``direct 
lobbying communication'' and ``grass roots lobbying communication''.
    (b) Influencing legislation: direct and grass roots lobbying 
communications defined.
    (1) Direct lobbying communication.
    (2) Grass roots lobbying communication.
    (3) Exceptions to the definition of influencing legislation.
    (4) Examples.
    (5) Special rule for certain mass media advertisements.
    (c) Exceptions to the definitions of direct lobbying communication 
and grass roots lobbying communication.
    (1) Nonpartisan analysis, study, or research exception.
    (2) Examinations and discussions of broad social, economic, and 
similar problems.
    (3) Requests for technical advice.
    (4) Communications pertaining to ``self-defense'' by the 
organization.
    (d) Definitions.
    (1) Legislation.
    (2) Action.
    (3) Legislative body.
    (4) Administrative bodies.

  Sec. 56.4911-3 Expenditures for direct and/or grass roots lobbying 
                             communications.

    (a) Definition of term ``expenditures for''.
    (1) In general.
    (2) Allocation of mixed purpose expenditures.
    (3) Allocation of mixed lobbying.
    (b) Examples.
    (c) Certain transfers treated as lobbying expenditures.
    (1) Transfer earmarked for grass roots purposes.
    (2) Transfer earmarked for direct and grass roots lobbying.
    (3) Certain transfers to noncharities that lobby.

              Sec. 56.4911-4 Exempt purpose expenditures.

    (a) Application.
    (b) Included expenditures.
    (c) Excluded expenditures.
    (d) Certain transfers treated as exempt purpose expenditures.
    (e) Transfers not exempt purpose expenditures.
    (f) Definitions.
    (g) Example.

              Sec. 56.4911-5 Communications with members.

    (a) In general.
    (b) Communications (directed only to members) that are not lobbying 
communications.
    (c) Communications (directed only to members) that are direct 
lobbying communications.
    (d) Communications (directed only to members) that are grass roots 
lobbying communications.
    (e) Written communications directed to members and nonmembers.
    (1) In general.
    (2) Direct lobbying directly encouraged.
    (3) Grass roots expenditure if grass roots lobbying directly 
encouraged.
    (4) No direct encouragement of direct lobbying or of grass roots 
lobbying.
    (f) Definitions and special rules.
    (1) Member; general rule.
    (2) Member; special rule.

[[Page 516]]

    (3) Member; affiliated group of organizations.
    (4) Member; limited affiliated group of organizations.
    (5) Subscriber.
    (6) Directly encourages.
    (7) Percentages of total distribution.
    (8) Reasonable allocation rule.

    Sec. 56.4911-6 Records of lobbying and grass roots expenditures.

    (a) Records of lobbying expenditures.
    (b) Records of grass roots expenditures.

           Sec. 56.4911-7 Affiliated group of organizations.

    (a) Affiliation between two organizations.
    (1) In general.
    (2) Organizations not described in section 501(c)(3).
    (3) Action on legislative issues.
    (b) Interlocking governing boards.
    (1) In general.
    (2) Majority or quorum.
    (3) Votes required under governing instrument or local law.
    (4) Representatives constituting less than 15% of governing board.
    (5) Representatives.
    (c) Governing instrument.
    (d) Three or more organizations affiliated.
    (1) Two controlled organizations affiliated.
    (2) Chain rule.
    (e) Affiliated group of organizations.
    (1) Defined.
    (2) Multiple membership.
    (3) Taxable year of affiliated group.
    (4) Electing member organization.
    (5) Election of member's year as group's taxable year.
    (f) Examples.

    Sec. 56.4911-8 Excess lobbying expenditures of affiliated group.

    (a) Application.
    (b) Affiliated group treated as one organization.
    (c) Tax imposed on excess lobbying expenditures of affiliated group.
    (d) Liability for tax.
    (1) Electing organizations.
    (2) Tax based on excess lobbying expenditures.
    (3) Tax based on excess grass roots expenditures.
    (4) Tax based on exempt purpose expenditures.
    (5) Taxable year for which liable.
    (6) Organization a member of more than one affiliated group.
    (e) Former member organizations.

 Sec. 56.4911-9 Application of section 501(h) to affiliated groups of 
                             organizations.

    (a) Scope.
    (b) Determination required.
    (c) Member organizations that are not electing organizations.
    (d) Filing of information relating to affiliated group of 
organizations.
    (1) Scope.
    (2) In general.
    (3) Additional information required.
    (4) Information required of electing member organization.
    (e) Example.
    (f) Cross reference.

Sec. 56.4911-10 Members of a limited affiliated group of organizations.

    (a) Scope.
    (b) Members of limited affiliated group.
    (c) Controlling and controlled organizations.
    (d) Expenditures of controlling organization.
    (1) Scope.
    (2) Expenditures for direct lobbying.
    (3) Grass roots expenditures.
    (4) Exempt purpose expenditures.
    (e) Expenditures of controlled member.
    (f) Reports of members of limited affiliated groups.
    (1) Controlling member organization's additional information on 
annual return.
    (2) Reports of controlling members to other members.
    (3) Reports of controlled member organizations.
    (g) National legislative issues.
    (h) Examples.

Sec. 56.6001-1 Notice or regulations requiring records, statements, and 
                            special returns.

    (a) In general.
    (b) Cross references.

   Sec. 56.6011-1 General requirement of return, statement, or list.



Sec. 56.4911-1  Tax on excess lobbying expenditures.

    (a) In general. Section 4911(a) imposes an excise tax of 25 percent 
on the excess lobbying expenditures (as defined in paragraph (b) of this 
section) for a taxable year of an organization for which the expenditure 
test election under section 501(h) is in effect (an ``electing public 
charity''). An electing public charity's annual limit on expenditures 
for influencing legislation (i.e., the amount of lobbying expenditures 
on which no tax is due) is the lobbying nontaxable amount or, on 
expenditures for influencing legislation through grass roots lobbying, 
the grass roots nontaxable amount (see paragraph (c) of this section). 
For rules

[[Page 517]]

concerning the application of the excise tax imposed by section 4911(a) 
to the members of an affiliated group of organizations (as defined in 
Sec. 56.4911-7(e)), see Sec. 56.4911-8.
    (b) Excess lobbying expenditures. For any taxable year for which the 
expenditure test election under section 501(h) is in effect, the amount 
of an electing public charity's excess lobbying expenditures is the 
greater of--
    (1) The amount by which the organization's lobbying expenditures 
(within the meaning of Sec. 56.4911-2(a)) exceed the organization's 
lobbying nontaxable amount, or
    (2) The amount by which the organization's grass roots expenditures 
(within the meaning of Sec. Sec. 56.4911-2(a)) exceed the 
organization's grass roots nontaxable amount.
    (c) Nontaxable amounts--(1) Lobbying nontaxable amount. Under 
section 4911(c)(2), the lobbying nontaxable amount for any taxable year 
for which the expenditure test election is in effect is the lesser of--
    (i) $1,000,000, or
    (ii) To the extent of the electing public charity's exempt purpose 
expenditures (within the meaning of Sec. 56.4911-4) for that year, the 
sum of 20 percent of the first $500,000 of such expenditures, plus 15 
percent of the second $500,000 of such expenditures, plus 10 percent of 
the third $500,000 of such expenditures, plus 5 percent of the remainder 
of such expenditures.
    (2) Grass roots nontaxable amount. Under section 4911(c)(4), an 
electing public charity's grass roots nontaxable amount for any taxable 
year is 25 percent of its lobbying nontaxable amount for that year.
    (d) Examples. The provisions of this section are illustrated by the 
examples in Sec. 1.501(h)-3.



Sec. 56.4911-2  Lobbying expenditures, direct lobbying communications,
and grass roots lobbying communications.

    (a) Lobbying expenditures--(1) In general. An electing public 
charity's lobbying expenditures for a year are the sum of its 
expenditures during that year for direct lobbying communications 
(``direct lobbying expenditures'') plus its expenditures during that 
year for grass roots lobbying communications (``grass roots 
expenditures'').
    (2) Overview of Sec. 56.4911-2 and the definitions of ``direct 
lobbying communication'' and ``grass roots lobbying communication''. 
Paragraph (b)(1) of this section defines the term ``direct lobbying 
communication.'' Paragraph (b)(2) of this section provides the general 
definition of the term ``grass roots lobbying communication.'' (But also 
see paragraph (b)(5) of this section (special rebuttable presumption 
regarding certain paid mass media communications) and Sec. 56.4911-5 
(special, more lenient, definitions for certain communications from an 
electing public charity to its bona fide members)). Paragraph (b)(3) of 
this section lists and cross-references various exceptions to the 
definitions set forth in paragraphs (b) (1) and (2) (the text of the 
exceptions, along with relevant definitions and examples, is generally 
set forth in paragraph (c)). Paragraph (b)(4) of this section contains 
numerous examples illustrating the application of paragraphs (b) (1), 
(2) and (3). As mentioned above, paragraph (b)(5) of this section sets 
forth the special rebuttable presumption regarding a limited number of 
paid mass media communications about highly publicized legislation. 
Paragraph (d) of this section contains definitions of (and examples 
illustrating) various terms used in this section.
    (b) Influencing legislation: direct and grass roots lobbying 
communications defined--(1) Direct lobbying communication--(i) 
Definition. A direct lobbying communication is any attempt to influence 
any legislation through communication with:
    (A) Any member or employee of a legislative body; or
    (B) Any government official or employee (other than a member or 
employee of a legislative body) who may participate in the formulation 
of the legislation, but only if the principal purpose of the 
communication is to influence legislation.
    (ii) Required elements. A communication with a legislator or 
government official will be treated as a direct lobbying communication 
under this Sec. 56.4911-2(b)(1) if, but only if, the communication:

[[Page 518]]

    (A) Refers to specific legislation (see paragraph (d)(1) of this 
section for a definition of the term ``specific legislation''); and
    (B) Reflects a view on such legislation.
    (iii) Special rule for referenda, ballot initiatives or similar 
procedures. Solely for purposes of this section 4911, where a 
communication refers to and reflects a view on a measure that is the 
subject of a referendum, ballot initiative or similar procedure, the 
general public in the State or locality where the vote will take place 
constitutes the legislative body, and individual members of the general 
public area, for purposes of this paragraph (b)(1), legislators. 
Accordingly, if such a communication is made to one or more members of 
the general public in that state or locality, the communication is a 
direct lobbying communication (unless it is nonpartisan analysis, study 
or research (see paragraph (c)(1) of this section).
    (2) Grass roots lobbying communication--(i) Definition. A grass 
roots lobbying communication is any attempt to influence any legislation 
through an attempt to affect the opinions of the general public or any 
segment thereof.
    (ii) Required elements. A communication will be treated as a grass 
roots lobbying communication under this Sec. 56.4911-2(b)(2)(ii) if, 
but only if, the communication:
    (A) Refers to specific legislation (see paragraph (d)(1) of this 
section for a definition of the term ``specific legislation'');
    (B) Reflects a view on such legislation; and
    (C) Encourages the recipient of the communication to take action 
with respect to such legislation (see paragraph (b)(2)(iii) of this 
section for the definition of encouraging the recipient to take action.

For special, more lenient rules regarding an organization's 
communications directed only or primarily to bona fide members of the 
organization, see Sec. 56.4911-5. For special rules regarding certain 
paid mass media advertisements about highly publicized legislation, see 
paragraph (b)(5) of this section. For special rules regarding lobbying 
on referenda, ballot initiatives and similar procedures, see paragraph 
(b)(1)(iii) of this section).
    (iii) Definition of encouraging recipient to take action. For 
purposes of this section, encouraging a recipient to take action with 
respect to legislation means that the communication:
    (A) States that the recipient should contact a legislator or an 
employee of a legislative body, or should contact any other government 
official or employee who may participate in the formulation of 
legislation (but only if the principal purpose of urging contact with 
the government official or employee is to influence legislation);
    (B) States the address, telephone number, or similar information of 
a legislator or an employee of a legislative body;
    (C) Provides a petition, tear-off postcard or similar material for 
the recipient to communicate with a legislator or an employee of a 
legislative body, or with any other government official or employee who 
may participate in the formulation of legislation (but only if the 
principal purpose of so facilitating contact with the government 
official or employee is to influence legislation); or
    (D) Specifically identifies one or more legislators who will vote on 
the legislation as: opposing the communication's view with respect to 
the legislation; being undecided with respect to the legislation; being 
the recipient's representative in the legislature; or being a member of 
the legislative committee or subcommittee that will consider the 
legislation. Encouraging the recipient to take action under this 
paragraph (b)(2)(iii)(D) does not include naming the main sponsor(s) of 
the legislation for purposes of identifying the legislation.
    (iv) Definition of directly encouraging recipient to take action. 
Communications described in one or more of paragraphs (b)(2)(iii) (A) 
through (C) of this section not only ``encourage,'' but also ``directly 
encourage'' the recipient to take action with respect to legislation. 
Communications described in paragraph (b)(2)(iii)(D) of this section, 
however, do not directly encourage the recipient to take action with 
respect to legislation. Thus, a communication would encourage the 
recipient to take

[[Page 519]]

action with respect to legislation, but not directly encourage such 
action, if the communication does no more than identify one or more 
legislators who will vote on the legislation as: opposing the 
communication's view with respect to the legislation; being undecided 
with respect to the legislation; being the recipient's representative in 
the legislature; or being a member of the legislative committee or 
subcommittee that will consider the legislation. Communications that 
encourage the recipient to take action with respect to legislation but 
that do not directly encourage the recipient to take action with respect 
to legislation may be within the exception for nonpartisan analysis, 
study or research (se paragraph (c)(1) of this section) and thus not be 
grass roots lobbying communications.
    (v) Subsequent lobbying use of nonlobbying communications or 
research materials--(A) Limited effect of application. Even though 
certain communications or research materials are initially not grass 
roots lobbying communications under the general definition set forth in 
paragraph (b)(2)(ii) of this section, subsequent use of the 
communications or research materials for grass roots lobbying may cause 
them to be treated as grass roots lobbying communications. This 
paragraph (b)(2)(v) does not cause any communications or research 
materials to be considered direct lobbying communications.
    (B) Limited scope of application. Under this paragraph (b)(2)(v), 
only ``advocacy communications or research materials'' are potentially 
treated as grass roots lobbying communications. Communications or 
research materials that are not ``advocacy communications or research 
materials'' are not treated as grass roots lobbying communications under 
this paragraph (b)(2)(v). ``Advocacy communications or research 
materials'' are any communications or materials that both refer to and 
reflect a view on specific legislation but that do not, in their initial 
format, contain a direct encouragement for recipients to take action 
with respect to legislation.
    (C) Subsequent use in lobbying. Where advocacy communications or 
research materials are subsequently accompanied by a direct 
encouragement for recipients to take action with respect to legislation, 
the advocacy communications or research materials themselves are treated 
as grass roots lobbying communications unless the organization's primary 
purpose in undertaking or preparing the advocacy communications or 
research materials was not for use in lobbying. In such a case, all 
expenses of preparing and distributing the advocacy communications or 
research materials will be treated as grass roots expenditures.
    (D) Time limit on application of subsequent use rule. The 
characterization of expenditures as grass roots lobbying expenditures 
under paragraph (b)(2)(v)(C) shall apply only to expenditures paid less 
than six months before the first use of the advocacy communications or 
research materials with a direct encouragement to action.
    (E) Safe harbor in determining ``primary purpose''. The primary 
purpose of the organization in undertaking or preparing advocacy 
communications or research materials will not be considered to be for 
use in lobbying if, prior to or contemporaneously with the use of the 
advocacy communications or research materials with the direct 
encouragement to action, the organization makes a substantial 
nonlobbying distribution of the advocacy communications or research 
materials (without the direct encouragement to action). Whether a 
distribution is substantial will be determined by reference to all of 
the facts and circumstances, including the normal distribution pattern 
of similar nonpartisan analyses, studies or research by that and similar 
organizations.
    (F) Special rule for partisan analysis, study or research. In the 
case of advocacy communications or research materials that are not 
nonpartisan analysis, study or research, the nonlobbying distribution 
thereof will not be considered ``substantial'' unless that distribution 
is at least as extensive as the lobbying distribution thereof.
    (G) Factors considered in determining primary purpose. Where the 
nonlobbying

[[Page 520]]

distribution of advocacy communications or research materials is not 
substantial, all of the facts and circumstances must be weighed to 
determine whether the organization's primary purpose in preparing the 
advocacy communications or research materials was for use in lobbying. 
While not the only factor, the extent of the organization's nonlobbying 
distribution of the advocacy communications or research materials is 
particularly relevant, especially when compared to the extent of their 
distribution with the direct encouragement to action. Another 
particularly relevant factor is whether the lobbying use of the advocacy 
communications or research materials is by the organization that 
prepared the document, a related organization, or an unrelated 
organization. Where the subsequent lobbying distribution is made by an 
unrelated organization, clear and convincing evidence (which must 
include evidence demonstrating cooperation or collusion between the two 
organizations) will be required to establish that the primary purpose 
for preparing the communication for use in lobbying.
    (H) Examples. The provisions of this paragraph (b)(2)(v) are 
illustrated by the following examples:

    Example 1. Assume a nonlobbying ``report'' (that is not nonpartisan 
analysis, study or research) is prepared by an organization, but 
distributed to only 50 people. The report, in that format, refers to and 
reflects a view on specific legislation but does not contain a direct 
encouragement for the recipients to take action with respect to 
legislation. Two months later, the organization sends the report to 
10,000 people along with a letter urging recipients to write their 
Senators about the legislation discussed in the report. Because the 
report's nonlobbying distribution is not as extensive as its lobbying 
distribution, the report's nonlobbying distribution is not substantial 
for purposes of this paragraph (b)(2)(v). Accordingly, the 
organization's primary purpose in preparing the report must be 
determined by weighing all of the facts and circumstances. In light of 
the relatively minimal nonlobbying distribution and the fact that the 
lobbying distribution is by the preparing organization rather than by an 
unrelated organization, and in the absence of evidence to the contrary, 
both the report and the letter are grass roots lobbying communications. 
Assume that all costs of preparing the report were paid within the six 
months preceding the mailing of the letter. Accordingly, all of the 
organization's expenditures for preparing and mailing the two documents 
are grass roots lobbying expenditures.
    Example 2. Assume the same facts as in Example (1), except that the 
costs of the report are paid over the two month period of January and 
February. Between January 1 and 31, the organization pays $1,000 for the 
report. In February, the organization pays $500 for the report. Further 
assume that the report is first used with a direct encouragement to 
action on August 1. Six months prior to August 1 is February 1. 
Accordingly, no costs paid for the report before February 1 are treated 
as grass roots lobbying expenditures under the subsequent use rule. 
Under these facts, the subsequent use rule treats only the $500 paid for 
the report in February as grass roots lobbying expenditures.

    (3) Exceptions to the definition of influencing legislation. In many 
cases, a communication is not a direct or grass roots lobbying 
communication under paragraph (b)(1) or (b)(2) of this section if it 
falls within one of the exceptions listed in paragraph (c) of this 
section. See paragraph (c)(1), Nonpartisan analysis, study or research; 
paragraph (c)(2), Examinations and discussions of broad social, economic 
and similar problems; paragraph (c)(3), Requests for technical advice; 
and paragraph (c)(4), Communications pertaining to self-defense by the 
organization. In addition, see Sec. 56.4911-5, which provides special 
rules regarding the treatment of certain lobbying communications 
directed in whole or in part to members of an electing public charity.
    (4) Examples. This paragraph (b)(4) provides examples to illustrate 
the rules set forth in the section regarding direct and grass roots 
lobbying. The expenditure test election under section 501(h) is assumed 
to be in effect for all organizations discussed in the examples in this 
paragraph (b)(4). In addition, it is assumed that the special rules of 
Sec. 56.4911-5, regarding certain of a public charity's communications 
with its members, do not apply to any of the examples in this paragraph 
(b)(4).
    (i) Direct lobbying. The provisions of this section regarding direct 
lobbying communications are illustrated by the following examples:

    Example 1. Organization P's employee, X, is assigned to approach 
members of Congress to gain their support for a pending bill. X drafts

[[Page 521]]

and P prints a position letter on the bill. P distributes the letter to 
members of Congress. Additionally, X 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 direct lobbying 
communications.
    Example 2. Organization M's president writes a letter to the 
Congresswoman representing the district in which M is headquartered, 
requesting that the Congresswoman write an administrative agency 
regarding proposed regulations recently published by that agency. M's 
president also requests that the Congresswoman's letter to the agency 
state the Congresswoman's support of M's application for a particular 
type of permit granted by the agency. The letter written by M's 
president is not a direct lobbying communication.
    Example 3. Organization Z prepares a paper on a particular state's 
environmental problems. The paper does not reflect a view on any 
specific pending legislation or on any specific legislative proposal 
that Z either supports or opposes. Z's representatives give the paper to 
a state legislator. Z's paper is not a direct lobbying communication.
    Example 4. State X enacts a statute that requires the licensing of 
all day care providers. Agency B in State X is charged with preparing 
rules to implement the bill enacted by State X. One week after enactment 
of the bill, organization C sends a letter to Agency B providing 
detailed proposed rules that organization C suggests to Agency B as the 
appropriate standards to follow in implementing the statute on licensing 
of day care providers. Organization C's letter to Agency B is not a 
lobbying communication.
    Example 5. Organization B researches, prepares and prints a code of 
standards of minimum safety requirements in an area of common electrical 
wiring. Organization B sells the code of standards booklet to the public 
and its is widely used by professional in the installation of electrical 
wiring. A number of states have codified all, or part, of the code of 
standards as mandatory safety standards. On occasion, B lobbies state 
legislators for passage of the code of standards for safety reasons. 
Because the primary purpose of preparing the code of standards was the 
promotion of public safety and the standards were specifically used in a 
profession for that purpose, separate from any legislative requirement, 
the research, preparation, printing and public distribution of the code 
of standards is not an expenditure for a direct (or grass roots) 
lobbying communication. Costs, such as transportation, photocopying, and 
other similar expenses, incurred in lobbying state legislators for 
passage of the code of standards into law are expenditures for direct 
lobbying communications.
    Example 6. On the organization's own initiative, representatives of 
Organization F present written testimony to a Congressional committee. 
The news media report on the testimony of Organization F, detailing F's 
opposition to a pending bill. The testimony is a direct lobbying 
communication but is not a grass roots lobbying communication.
    Example 7. Organization R's monthly newsletter contains an editorial 
column that refers to and reflects a view on specific pending bills. R 
sends the newsletter to 10,000 nonmember subscribers. Senator Doe is 
among the subscribers. The editorial column in the newsletter copy sent 
to Senator Doe is not a direct lobbying communication because the 
newsletter is sent to Senator Doe in her capacity as a subscriber rather 
than her capacity as a legislator. (Note, though, that the editorial 
column may be a grass roots lobbying communication if it encourages 
recipients to take action with respect to the pending bills it refers to 
and on which it reflects a view).
    Example 8. Assume the same facts as in Example (7), except that one 
of Senator Doe's staff members sees Senator Doe's copy of the editorial 
and writes to R requesting additional information. R responds with a 
letter that refers to and reflects a view on specific legislation. R's 
letter is a direct lobbying communication unless it is within one of the 
exceptions set forth in paragraph (c) of this section (such as the 
exception for nonpartisan analysis, study or research). (R's letter is 
not within the scope of the exception for responses to written requests 
from a legislative body or committee for technical advice (see paragraph 
(c)(3) of this section) because the letter is not in response to a 
written request from a legislative body or committee).

    (ii) Grass roots lobbying. The provisions of this section regarding 
grass roots lobbying communications are illustrated in paragraph 
(b)(4)(ii)(A) of this section by examples of communications that are not 
grass roots lobbying communications and in paragraph (b)(4)(ii)(B) by 
examples of communications that are grass roots lobbying communications. 
The provisions of this section are further illustrated in paragraph 
(b)(4)(ii)(C), with particular regard to the exception for nonpartisan 
analysis, study, or research:
    (A) Communications that are not grass roots lobbying communications.

    Example 1. Organization L places in its newsletter an article that 
asserts that lack of new capital is hurting State W's economy. The 
article recommends that State W residents either invest more in local 
businesses or increase their savings so that funds will be available to 
others interested in making

[[Page 522]]

investments. The article is an attempt to influence opinions with 
respect to a general problem that might receive legislative attention 
and is distributed in a manner so as to reach and influence many 
individuals. However, the article does not refer to specific legislation 
that is pending in a legislative body, nor does the article refer to a 
specific legislative proposal the organization either supports or 
opposes. The article is not a grass roots lobbying communication.
    Example 2. Assume the same facts as Example (1), except that the 
article refers to a bill pending in State W's legislature that is 
intended to provide tax incentives for private savings. The article 
praises the pending bill and recommends that it be enacted. However, the 
article does not encourage readers to take action with respect to the 
legislation. The article is not a grass roots lobbying communication.
    Example 3. Organization B sends a letter to all persons on its 
mailing list. The letter includes an update on numerous environmental 
issues with a discussion of general concerns regarding pollution, 
proposed federal regulations affecting the area, and several pending 
legislative proposals. The letter endorses two pending bills and opposes 
another pending bill, but does not name any legislator involved (other 
than the sponsor of one bill, for purposes of identifying the bill), nor 
does it otherwise encourage the reader to take action with respect to 
the legislation. The letter is not a grass roots lobbying communication.
    Example 4. A pamphlet distributed by organization Z discusses the 
dangers of drugs and encourages the public to send their legislators a 
coupon, printed with the statement ``I support a drug-free America.'' 
The term ``drug-free America'' is not widely identified with any of the 
many specific pending legislative proposals regarding drug issues. The 
pamphlet does not refer to any of the numerous pending legislative 
proposals, nor does the organization support or oppose a specific 
legislative proposal. The pamphlet is not a grass roots lobbying 
communication.
    Example 5. A pamphlet distributed by organization B encourages 
readers to join an organization and ``get involved in the fight against 
drugs.'' The text states, in the course of a discussion of several 
current drug issues, that organization B supports a specific bill before 
Congress that would establish an expanded drug control program. The 
pamphlet does not encourage readers to communicate with legislators 
about the bill (such as by including the names of undecided or opposed 
legislators). The pamphlet is not a grass roots lobbying communication.
    Example 6. Organization E, an environmental organization, routinely 
summarizes in each edition of its newsletter the new environment-related 
bills that have been introduced in Congress since the last edition of 
the newsletter. The newsletter identifies each bill by a bill number and 
the name of the legislation's sponsor. The newsletter also reports on 
the status of previously introduced environment-related bills. The 
summaries and status reports do not encourage recipients of the 
newsletter to take action with respect to legislation, as described in 
paragraphs (b)(2)(iii) (A) through (D) of this section. Although the 
summaries and status reports refer to specific legislation and often 
reflect a view on such legislation, they do not encourage the newsletter 
recipients to take action with respect to such legislation. The 
summaries and status reports are not grass roots lobbying 
communications.
    Example 7. Organization B prints in its newsletter a report on 
pending legislation that B supports, the Family Equity bill. The report 
refers to and reflects a view on the Family Equity bill, but does not 
directly encourage recipients to take action. Nor does the report 
specifically identify any legislator as opposing the communication's 
view on the legislation, as being undecided, or as being a member of the 
legislative committee or subcommittee that will consider the 
legislation. However, the report does state the following:
    Rep. Doe (D-Ky.) and Rep. Roe (R-Ma.), both ardent supporters of the 
Family Equity bill, spoke at B's annual convention last week. Both 
encouraged B's efforts to get the Family Equity bill enacted and stated 
that they thought the bill could be enacted even over a presidential 
veto. B's legislative affairs liaison questioned others, who seemed to 
agree with that assessment. For example, Sen. Roe (I-Ca.) said that he 
thinks the bill will pass with such a large majority, ``the President 
won't even consider vetoing it.''
    Assume the newsletter, and thus the report, is sent to individuals 
throughout the U.S., including some recipients in Kentucky, 
Massachusetts and California. Because the report is distributed 
nationally, the mere fact that the report identifies several legislators 
by party and state as part of its discussion does not mean the report 
specifically identifies the named legislators as the Kentucky, 
Massachusetts and California recipients' representatives in the 
legislature for purposes of paragraph (b)(2)(iii) of this section. The 
report is not a grass roots lobbying communication.

    (B) Communications that are grass roots lobbying communications.

    Example 1. A pamphlet distributed by organization Y states that the 
``President's plan for a drug-free America,'' which will establish a 
drug control program, should be passed. The pamphlet encourages readers 
to ``write or call your senators and representatives and tell them to 
vote for the President's plan.'' No legislative proposal formally bears 
the name ``President's plan for a

[[Page 523]]

drug-free America,'' but that and similar terms have been widely used in 
connection with specific legislation pending in Congress that was 
initially proposed by the President. Thus, the pamphlet refers to 
specific legislation, reflects a view on the legislation, and encourages 
readers to take action with respect to the legislation. The pamphlet is 
a grass roots lobbying communication.
    Example 2. Assume the same facts as in Example (1), except that the 
pamphlet does not encourage the public to write or call representatives, 
but does list the members of the committee that will consider the bill. 
The pamphlet is a grass roots lobbying communication.
    Example 3. Assume the same facts as in Example (1), except that the 
pamphlet encourages readers to ``write the President to urge him to make 
the bill a top legislative priority'' rather than encouraging readers to 
communicate with members of Congress. The pamphlet is a grass roots 
lobbying communication.
    Example 4. Organization B, a nonmembership organization, includes in 
one of three sections of its newsletter an endorsement of two pending 
bills and opposition to another pending bill and also identifies several 
legislators as undecided on the three bills. The section of the 
newsletter devoted to the three pending bills is a grass roots lobbying 
communication.
    Example 5. Organization D, a nonmembership organization, sends a 
letter to all persons on its mailing list. The letter includes an 
extensive discussion concluding that a significant increase in spending 
for the Air Force is essential in order to provide an adequate defense 
of the nation. Prior to a concluding fundraising request, the letter 
encourages readers to write their Congressional representatives urging 
increased appropriations to build the B-1 bomber. The letter is a grass 
roots lobbying communication.
    Example 6. The President nominates X for a position in the 
President's cabinet. Organization Y disagrees with the views of X and 
does not believe X has the necessary administrative capabilities to 
effectively run a cabinet-level department. Accordingly, Y sends a 
general mailing requesting recipients to write to four Senators on the 
Senate Committee that will consider the nomination. The mailing is a 
grass roots lobbying communication.
    Example 7. Organization F mails letters requesting that each 
recipient contribute money to or join F. In addition, the letters 
express F's opposition to a pending bill that is to be voted upon by the 
U.S. House of Representatives. Although the letters are form letters 
sent as a mass mailing, each letter is individualized to report to the 
recipient the name of the recipient's congressional representative. The 
letters are grass roots lobbying communications.
    Example 8. Organization C sends a mailing that opposes a specific 
legislative proposal and includes a postcard addressed to the President 
for the recipient to sign stating opposition to the proposal. The letter 
requests that the recipient send to C a contribution as well as the 
postcard opposing the proposal. C states in the letter that it will 
deliver all the postcards to the White House. The letter is a grass 
roots lobbying communication.

    (C) Additional examples.

    Example 1. The newsletter of an organization concerned with drug 
issues is circulated primarily to individuals who are not members of the 
organization. A story in the newsletter reports on the prospects for 
passage of a specifically identified bill, stating that the organization 
supports the bill. The newsletter story identifies certain legislators 
as undecided, but does not state that readers should contact the 
undecided legislators. The story does not provide a full and fair 
exposition sufficient to qualify as nonpartisan analysis, study or 
research. The newsletter story is a grass roots lobbying communication.
    Example 2. Assume the same facts as in Example (1), except that the 
newsletter story provides a full and fair exposition sufficient to 
qualify as nonpartisan analysis, study or research. The newsletter story 
is not a grass roots lobbying communication because it is within the 
exception for nonpartisan analysis, study or research (since it does not 
directly encourage recipients to take action).
    Example 3. Assume the same facts as in Example (2), except that the 
newsletter story explicitly asks readers to contact the undecided 
legislators. Because the newsletter story directly encourages readers to 
take action with respect to the legislation, the newsletter story is not 
within the exception for nonpartisan analysis, study or research. 
Accordingly, the newsletter story is a grass roots lobbying 
communication.
    Example 4. Assume the same facts as in Example (1), except that the 
story does not identify any undecided legislators. The story is not a 
grass roots lobbying communication.
    Example 5. X organization places an advertisement that specifically 
identifies and opposes a bill that X asserts would harm the farm 
economy. The advertisement is not a mass media communication described 
in paragraph (b)(5)(ii) of this section and does not directly encourage 
readers to take action with respect to the bill. However, the 
advertisement does state that Senator Y favors the legislation. Because 
the advertisement refers to and reflects a view on specific legislation, 
and also encourages the readers to take action with respect to the 
legislation by specifically identifying a legislator who

[[Page 524]]

opposes X's views on the legislation, the advertisement is a grass roots 
lobbying communication.
    Example 6. Assume the same facts as in Example (5), except that 
instead of identifying Senator Y as favoring the legislation, the 
advertisement identifies the ``junior Senator from State Z'' as favoring 
the legislation. The advertisement is a grass roots lobbying 
communication.
    Example 7. Assume the same facts as in Example (5), except that 
instead of identifying Senator Y as favoring the legislation, the 
advertisement states: ``Even though this bill will have a devastating 
effect upon the farm economy, most of the Senators from the Farm Belt 
states are inexplicably in favor of the bill.'' The advertisement does 
not specifically identify one or more legislators as opposing the 
advertisement's view on the bill in question. Accordingly, the 
advertisement is not a grass roots lobbying communication because it 
does not encourage readers to take action with respect to the 
legislation.
    Example 8. Organization V trains volunteers to go door-to-door to 
seek signatures for petitions to be sent to legislators in favor of a 
specific bill. The volunteers are wholly unreimbursed for their time and 
expenses. The volunteers' costs (to the extent any are incurred) are not 
lobbying or exempt purpose expenditures made by V (but the volunteers 
may not deduct their out-of-pocket expenditures (see section 170(f)(6)). 
When V asks the volunteers to contact others and urge them to sign the 
petitions, V encourages those volunteers to take action in favor of the 
specific bill. Accordingly, V's costs of soliciting the volunteers' help 
and its costs of training the volunteers are grass roots expenditures. 
In addition, the costs of preparing, copying, distributing, etc. the 
petitions (and any other materials on the same specific subject used in 
the door-to-door signature gathering effort), are grass roots 
expenditures.

    (5) Special rule for certain mass media advertisements--(i) In 
general. A mass media advertisement that is not a grass roots lobbying 
communication under the three-part grass roots lobbying definition 
contained in paragraph (b)(2) of this section may be a grass roots 
lobbying communication by virtue of paragraph (b)(5)(ii) of this 
section. The special rule in paragraph (b)(5)(ii) generally applies only 
to a limited type of paid advertisements that appear in the mass media.
    (ii) Presumption regarding certain paid mass media advertisements 
about highly publicized legislation. If within two weeks before a vote 
by a legislative body, or a committee (but not a subcommittee) thereof, 
on a highly publicized piece of legislation, an organization's paid 
advertisement appears in the mass media, the paid advertisement will be 
presumed to be a grass roots lobbying communication, but only if the 
paid advertisement both reflects a view on the general subject of such 
legislation and either: refers to the highly publicized legislation; or 
encourages the public to communicate with legislators on the general 
subject of such legislation. An organization can rebut this presumption 
by demonstrating that the paid advertisement is a type of communication 
regularly made by the organization in the mass media without regard to 
the timing of legislation (that is, a customary course of business 
exception) or that the timing of the paid advertisement was unrelated to 
the upcoming legislative action. Notwithstanding the fact that an 
organization successfully rebuts the presumption, a mass media 
communication described in this paragraph (b)(5)(ii) is a grass roots 
lobbying communication if the communication would be a grass roots 
lobbying communication under the rules contained in paragraph (b)(2) of 
this section.
    (iii) Definitions--(A) Mass media. For purposes of this paragraph 
(b)(5), the term ``mass media'' means television, radio, billboards and 
general circulation newspapers and magazines. General circulation 
newspapers and magazines do not include newspapers or magazines 
published by an organization for which the expenditure test election 
under section 501(h) is in effect, except where both: The total 
circulation of the newspaper or magazine is greater than 100,000; and 
fewer than one-half of the recipients are members of the organization 
(as defined in Sec. 56.4911-5(f)).
    (B) Paid advertisement. For purposes of this paragraph (b)(5), where 
an electing public charity is itself a mass media publisher or 
broadcaster, all portions of that organization's mass media publications 
or broadcasts are treated as paid advertisements in the mass media, 
except those specific portions that are advertisements paid for by 
another person. The term ``mass media'' is defined in paragraph 
(b)(5)(iii)(A).

[[Page 525]]

    (C) Highly publicized. For purposes of this paragraph (b)(5), 
``highly publicized'' means frequent coverage on television and radio, 
and in general circulation newspapers, during the two weeks preceding 
the vote by the legislative body or committee. In the case of state or 
local legislation, ``highly publicized'' means frequent coverage in the 
mass media that serve the State or local jurisdiction in question. Even 
where legislation receives frequent coverage, it is ``highly 
publicized'' only if the pendency of the legislation or the 
legislation's general terms, purpose, or effect are known to a 
significant segment of the general public (as opposed to the particular 
interest groups directly affected) in the area in which the paid mass 
media advertisement appears.
    (iv) Examples. The special rule of this paragraph (b)(5) is 
illustrated by the following examples. The expenditure test election 
under section 501(h) is assumed to be in effect for all organizations 
discussed in the examples in this paragraph (b)(5)(iv):

    Example 1. Organization X places a television advertisement 
advocating one of the President's major foreign policy initiatives, as 
outlined by the President in a series of speeches and as drafted into 
proposed legislation. The initiative is popularly known as ``the 
President's World Peace Plan,'' and is voted upon by the Senate four 
days after X's advertisement. The advertisement concludes: ``SUPPORT THE 
PRESIDENT'S WORLD PEACE PLAN!'' The President's plan and position are 
highly publicized during the two weeks before the Senate vote, as 
evidenced by: coverage of the plan on several nightly television network 
news program; more than one article about the plan on the front page of 
a majority of the country's ten largest daily general circulation 
newspapers; and an editorial about the plan in four of the country's ten 
largest daily general circulation newspapers. Although the advertisement 
does not encourage readers to contact legislators or other government 
officials, the advertisement does refer to specific legislation and 
reflect a view on the general subject of the legislation. The 
communication is presumed to be a grass roots lobbying communication.
    Example 2. Assume the same facts as in Example (1), except that the 
advertisement appears three weeks before the Senate's vote on the plan. 
Because the advertisement appears more than two weeks before the 
legislative vote, the advertisement is not within the scope of the 
special rule for mass media communications on highly publicized 
legislation. Accordingly, the advertisement is a grass roots lobbying 
communication only if it is described in the general definition 
contained in paragraph (b)(2) of this section. Because the advertisement 
does not encourage recipients to take action with respect to the 
legislation in question, the advertisement is not a grass roots lobbying 
communication.
    Example 3. Organization Y places a newspaper advertisement 
advocating increased government funding for certain public works 
projects the President has proposed and that are being considered by a 
legislative committee. The advertisement explains the President's 
proposals and concludes: ``SUPPORT FUNDING FOR THESE VITAL PROJECTS!'' 
The advertisement does not encourage readers to contact legislators or 
other government officials nor does it name any undecided legislators, 
but it does name the legislation being considered by the committee. The 
President's proposed funding of public works, however, is not highly 
publicized during the two weeks before the vote: there has been little 
coverage of the issue on nightly television network news programs, only 
one front-page article on the issue in the country's ten largest daily 
general circulation newspapers, and only one editorial about the issue 
in the country's ten largest daily general circulation newspapers. Two 
days after the advertisement appears, the committee votes to approve 
funding of the projects. Although the advertisement appears less than 
two weeks before the legislative vote, the advertisement is not within 
the scope of the special rule for mass media communications on highly 
publicized legislation because the issue of funding for public works 
projects is not highly publicized. Thus, the advertisement is a grass 
roots lobbying communication only if it is described in the general 
definition contained in paragraph (b)(2) of this section. Because the 
advertisement does not encourage recipients to take action with respect 
to the legislation in question, the advertisement is not a grass roots 
lobbying communication.
    Example 4. Organization P places numerous advertisements in the mass 
media about a bill being considered by the State Assembly. The bill is 
highly publicized, as evidenced by numerous front-page articles, 
editorials and letters to the editor published in the state's general 
circulation daily newspapers, as well as frequent coverage of the bill 
by the television and radio stations serving the state. The 
advertisements run over a three week period and, in addition to showing 
pictures of a family being robbed at gunpoint, say: ``The State Assembly 
is considering a bill to make gun ownership illegal. This outrageous 
legislation would violate your constitutional rights and the rights of 
other law-abiding citizens. If this legislation is passed, you and your 
family will be criminals if you want to

[[Page 526]]

exercise your right to protect yourselves.'' The advertisements refer to 
and reflect a view on a specific bill but do not encourage recipients to 
take action. Sixteen days after the last advertisement runs, a State 
Assembly committee votes to defeat the legislation. None of the 
advertisements is a grass roots lobbying communication.
    Example 5. Assume the same facts as in Example (4), except that it 
is publicly announced prior to the advertising campaign that the 
committee vote is scheduled for five days after the last advertisement 
runs. Because of public pressure resulting from the advertising 
campaign, the bill is withdrawn and no vote is ever taken. None of the 
advertisements is a grass roots lobbying communication.

    (c) Exceptions to the definitions of direct lobbying communication 
and grass roots lobbying communication--(1) Nonpartisan analysis, study, 
or research exception--(i) In general. Engaging in nonpartisan analysis, 
study, or research and making available to the general public or a 
segment or members thereof or to governmental bodies, officials, or 
employees the results of such work constitute neither a direct lobbying 
communication under Sec. 56.4911-2(b)(1) nor a grass roots lobbying 
communication under Sec. 56.4911-2(b)(2).
    (ii) Nonpartisan analysis, study, or research. For purposes of this 
section, ``nonpartisan analysis, study, or research'' means an 
independent and objective exposition of a particular subject matter, 
including any activity that is ``educational'' within the meaning of 
Sec. 1.501(c)(3)-1(d)(3). Thus, ``nonpartisan analysis, study, or 
research'' may advocate a particular position or viewpoint so long as 
there is a sufficiently full and fair exposition of the pertinent facts 
to enable the public or an individual to form an independent opinion or 
conclusion. The mere presentation of unsupported opinion, however, does 
not qualify as ``nonpartisan analysis, study, or research''.
    (iii) Presentation as part of a series. Normally, whether a 
publication or broadcast qualifies as ``nonpartisan analysis, study, or 
research'' will be determined on a presentation-by-presentation basis. 
However, if a publication or broadcast is one of a series prepared or 
supported by an electing organization and the series as a whole meets 
the standards of paragraph (c)(1)(ii) of this section, then any 
individual publication or broadcast within the series is not a direct or 
grass roots lobbying communication even though such individual broadcast 
or publication does not, by itself, meet the standards of paragraph 
(c)(1)(ii) of this section. Whether a broadcast or publication is 
considered part of a series will ordinarily depend upon all the facts 
and circumstances of each particular situation. However, with respect to 
broadcast activities, all broadcasts within any period of six 
consecutive months will oridinarily be eligible to be considered as part 
of a series. If an electing organization times or channels a part of a 
series which is described in this paragraph (c)(1)(iii) in a manner 
designed to influence the general public or the action of a legislative 
body with respect to a specific legislative proposal, the expenses of 
preparing and distributing such part of the analysis, study, or research 
will be expenditures for a direct or grass roots lobbying 
communications, as the case may be.
    (iv) Making available results of nonpartisan analysis, study, or 
research. An organization may choose any suitable means, including oral 
or written presentations, to distribute the results of its nonpartisan 
analysis, study, or research, with or without charge. Such means include 
distribution of reprints of speeches, articles and reports; presentation 
of information through conferences, meetings and discussions; and 
dissemination to the news media, including radio, television and 
newspapers, and to other public forums. For purposes of this paragraph 
(c)(1)(iv), such communications may not be limited to, or be directed 
toward, persons who are interested solely in one side of a particular 
issue.
    (v) Subsequent lobbying use of certain analysis, study or research. 
Even though certain analysis, study or research is initially within the 
exception for nonpartisan analysis, study or research, subsequent use of 
that analysis, study or research for grass roots lobbying may cause that 
analysis, study or research to be treated as a grass roots lobbying 
communication that is not within the exception for nonpartisan analysis, 
study or research. This paragraph (c)(1)(v) does not cause any analysis, 
study or research to be considered

[[Page 527]]

a direct lobbying communication. For rules regarding when analysis, 
study or research is treated as a grass roots lobbying communication 
that is not within the scope of the exception for nonpartisan analysis, 
study or research, see paragraph (b)(2)(v) of this section.
    (vi) Directly encouraging action by recipients of a communication. A 
communication that reflects a view on specific legislation is not within 
the nonpartisan analysis, study, or research exception of this paragraph 
(c)(1) if the communication directly encourages the recipient to take 
action with respect to such legislation. For purposes of this section, a 
communication directly encourages the recipient to take action with 
respect to legislation if the communication is described in one or more 
of paragraphs (b)(2)(iii) (A) through (C) of this section. As described 
in paragraph (b)(2)(iv) of this section, a communication would encourage 
the recipient to take action with respect to legislation, but not 
directly encourage such action, if the communication does no more than 
specifically identify one or more legislators who will vote on the 
legislation as: opposing the communication's view with respect to the 
legislation; being undecided with respect to the legislation; being the 
recipient's representative in the legislature; or being a member of the 
legislative committee or subcommittee that will consider the 
legislation.
    (vii) Examples. The provisions of this paragraph (c)(1) may be 
illustrated by the following examples:

    Example 1. Organization M establishes a research project to collect 
information for the purpose of showing the dangers of the use of 
pesticides in raising crops. The information collected includes data 
with respect to proposed legislation, pending before several State 
legislatures, which would ban the use of pesticides. The project takes 
favorable positions on such legislation without producing a sufficiently 
full and fair exposition of the pertinent facts to enable the public or 
an individual to form an independent opinion or conclusion on the pros 
and cons of the use of pesticides. This project is not within the 
exception for nonpartisan analysis, study, or research because it is 
designed to present information merely on one side of the legislative 
controversy.
    Example 2. Organization N establishes a research project to collect 
information concerning the dangers of the use of pesticides in raising 
crops for the ostensible purpose of examining and reporting information 
as to the pros and cons of the use of pesticides in raising crops. The 
information is collected and distributed in the form of a published 
report which analyzes the effects and costs of the use and nonuse of 
various pesticides under various conditions on humans, animals and 
crops. The report also presents the advantages, disadvantages, and 
economic cost of allowing the continued use of pesticides unabated, of 
controlling the use of pesticides, and of developing alternatives to 
pesticides. Even if the report sets forth conclusions that the 
disadvantages as a result of using pesticides are greater than the 
advantages of using pesticides and that prompt legislative regulation of 
the use of pesticides is needed, the project is within the exception for 
nonpartisan analysis, study, or research since it is designed to present 
information on both sides of the legislative controversy and presents a 
sufficiently full and fair exposition of the pertinent facts to enable 
the public or an individual to form an independent opinion or 
conclusion.
    Example 3. Organization O establishes a research project to collect 
information on the presence or absence of disease in humans from eating 
food grown with pesticides and the presence or absence of disease in 
humans from eating food not grown with pesticides. As part of the 
research project, O hires a consultant who prepares a ``fact sheet'' 
which calls for the curtailment of the use of pesticides and which 
addresses itself to the merits of several specific legislative proposals 
to curtail the use of pesticides in raising crops which are currently 
pending before State Legislatures. The ``fact sheet'' presents reports 
of experimental evidence tending to support its conclusions but omits 
any reference to reports of experimental evidence tending to dispute its 
conclusions. O distributes ten thousand copies to citizens' groups. 
Expenditures by O in connection with this work of the consultant are not 
within the exception for nonpartisan analysis, study, or research.
    Example 4. P publishes a bi-monthly newsletter to collect and report 
all published materials, ongoing research, and new developments with 
regard to the use of pesticides in raising crops. The newsletter also 
includes notices of proposed pesticide legislation with impartial 
summaries of the provisions and debates on such legislation. The 
newsletter does not encourage recipients to take action with respect to 
such legislation, but is designed to present information on both sides 
of the legislative controversy and does present such information fully 
and fairly. It is within the exception for nonpartisan analysis, study, 
or research.

[[Page 528]]

    Example 5. X is satisfied that A, a member of the faculty of Y 
University, is exceptionally well qualified to undertake a project 
involving a comprehensive study of the effects of pesticides on crop 
yields. Consequently, X makes a grant to A to underwrite the cost of the 
study and of the preparation of a book on the effect of pesticides on 
crop yields. X does not take any position on the issues or control the 
content of A's output. A produces a book which concludes that the use of 
pesticides often has a favorable effect on crop yields, and on that 
basis argues against pending bills which would ban the use of 
pesticides. A's book contains a sufficiently full and fair exposition of 
the pertinent facts, including known or potential disadvantages of the 
use of pesticides, to enable the public or an individual to form an 
independent opinion or conclusion as to whether pesticides should be 
banned as provided in the pending bills. The book does not directly 
encourage readers to take action with respect to the pending bills. 
Consequently, the book is within the exception for nonpartisan analysis, 
study, or research.
    Example 6. Assume the same facts as Example (2), except that, 
instead of issuing a report, X presents within a period of 6 consecutive 
months a two-program television series relating to the pesticide issue. 
The first program contains information, arguments, and conclusions 
favoring legislation to restrict the use of pesticides. The second 
program contains information, arguments, and conclusions opposing 
legislation to restrict the use of pesticides. The programs are 
broadcast within 6 months of each other during commensurate periods of 
prime time. X's programs are within the exception for nonpartisan 
analysis, study, or research. Although neither program individually 
could be regarded as nonpartisan, the series of two programs constitutes 
a balanced presentation.
    Example 7. Assume the same facts as in Example (6), except that X 
arranged for televising the program favoring legislation to restrict the 
use of pesticides at 8:00 on a Thursday evening and for televising the 
program opposing such legislation at 7:00 on a Sunday morning. X's 
presentation is not within the exception for nonpartisan analysis, 
study, or research, since X disseminated its information in a manner 
prejudicial to one side of the legislative controversy.
    Example 8. Organization Z researches, writes, prints and distributes 
a study on the use and effects of pesticide X. A bill is pending in the 
U.S. Senate to ban the use of pesticide X. Z's study leads to the 
conclusion that pesticide X is extremely harmful and that the bill 
pending in the U.S. Senate is an appropriate and much needed remedy to 
solve the problems caused by pesticide X. The study contains a 
sufficiently full and fair exposition of the pertinent facts, including 
known or potential advantages of the use of pesticide X, to enable the 
public or an individual to form an independent opinion or conclusion as 
to whether pesticides should be banned as provided in the pending bills. 
In its analysis of the pending bill, the study names certain undecided 
Senators on the Senate committee considering the bill. Although the 
study meets the three part test for determining whether a communication 
is a grass roots lobbying communication, the study is within the 
exception for nonpartisan analysis, study or research, because it does 
not directly encourage recipients of the communication to urge a 
legislator to oppose the bill.
    Example 9. Assume the same facts as in Example (8), except that, 
after stating support for the pending bill, the study concludes: ``You 
should write to the undecided committee members to support this crucial 
bill.'' The study is not within the exception for nonpartisan analysis, 
study or research because it directly encourages the recipients to urge 
a legislator to support a specific piece of legislation.
    Example 10. Organization X plans to conduct a lobbying campaign with 
respect to illegal drug use in the United States. It incurs $5,000 in 
expenses to conduct research and prepare an extensive report primarily 
for use in the lobbying campaign. Although the detailed report discusses 
specific pending legislation and reaches the conclusion that the 
legislation would reduce illegal drug use, the report contains a 
sufficiently full and fair exposition of the pertinent facts to enable 
the public or an individual to form an independent conclusion regarding 
the effect of the legislation. The report does not encourage readers to 
contact legislators regarding the legislation. Accordingly, the report 
does not, in and of itself, constitute a lobbying communication.
    Copies of the report are available to the public at X's office, but 
X does not actively distribute the report or otherwise seek to make the 
contents of the report available to the general public. Whether or not 
X's distribution is sufficient to meet the requirement in Sec. 56.4911-
2(c)(1)(iv) that a nonpartisan communication be made available, X's 
distribution is not substantial (for purposes of Sec. 56.4911-
2(b)(2)(v)(E)) in light of all of the facts and circumstances, including 
the normal distribution pattern of similar nonpartisan reports. X then 
mails copies of the report, along with a letter, to 10,000 individuals 
on X's mailing list. In the letter, X requests that individuals contact 
legislators urging passage of the legislation discussed in the report. 
Because X's research and report were primarily undertaken by X for 
lobbying purposes and X did not make a substantial

[[Page 529]]

distribution of the report (without an accompanying lobbying message) 
prior to or contemporaneously with the use of the report in lobbying, 
the report is a grass roots lobbying communication that is not within 
the exception for nonpartisan analysis, study or research.
    Example 11. Assume the same facts as in Example (10), except that 
before using the report in the lobbying campaign, X sends the research 
and report (without an accompanying lobbying message) to universities 
and newspapers. At the same time, X also advertises the availability of 
the report in its newsletter. This distribution is similar in scope to 
the normal distribution pattern of similar nonpartisan reports. In light 
of all of the facts and circumstances, X's distribution of the report is 
substantial. Because of X's substantial distribution of the report, X's 
primary purpose will be considered to be other than for use in lobbying 
and the report will not be considered a grass roots lobbying 
communication. Accordingly, only the expenditures for copying and 
mailing the report to the 10,000 individuals on X's mailing list, as 
well as for preparing and mailing the letter, are expenditures for grass 
roots lobbying communications.
    Example 12. Organization M pays for a bumper sticker that reads: 
``STOP ABORTION: Vote NO on Prop. X!'' M also pays for a 30-second 
television advertisement and a billboard that similarly advocate 
opposition to Prop. X. In light of the limited scope of the 
communications, none of the communications is within the exception for 
nonpartisan analysis, study or research. First, none of the 
communications rises to the level of analysis, study or research. 
Second, none of the communications is nonpartisan because none contains 
a sufficiently full and fair exposition of the pertinent facts to enable 
the public or an individual to form an independent opinion or 
conclusion. Thus, each communication is a direct lobbying communication.

    (2) Examinations and discussions of broad social, economic, and 
similar problems. Examinations and discussions of broad social, 
economic, and similar problems are neither direct lobbying 
communications under Sec. 56.4911-2(b)(1) nor grass roots lobbying 
communications under Sec. 56.4911-2(b)(2) even if the problems are of 
the type with which government would be expected to deal ultimately. 
Thus, under Sec. Sec. 56.4911-2(b) (1) and (2), lobbying communications 
do not include public discussion, or communications with members of 
legislative bodies or governmental employees, the general subject of 
which is also the subject of legislation before a legislative body, so 
long as such discussion does not address itself to the merits of a 
specific legislative proposal and so long as such discussion does not 
directly encourage recipients to take action with respect to 
legislation. For example, this paragraph (c)(2) excludes from grass 
roots lobbying under Sec. 56.4911-2(b)(2) an organization's discussions 
of problems such as environmental pollution or population growth that 
are being considered by Congress and various State legislatures, but 
only where the discussions are not directly addressed to specific 
legislation being considered, and only where the discussions do not 
directly encourage recipients of the communication to contact a 
legislator, an employee of a legislative body, or a government official 
or employee who may participate in the formulation of legislation.
    (3) Requests for technical advice. A communication is not a direct 
lobbying communication under Sec. 56.4911-2(b)(1) if the communication 
is the providing of technical advice or assistance to a governmental 
body, a governmental committee, or a subdivision of either in response 
to a written request by the body, committee, or subdivision, as set 
forth in Sec. 53.4945-2(d)(2).
    (4) Communications pertaining to ``self-defense'' by the 
organization. A communication is not a direct lobbying communication 
under Sec. 56.4911-2(b)(1) if either:
    (i) The communication is an appearance before, or communication 
with, any legislative body with respect to a possible action by the body 
that might affect the existence of the electing public charity, its 
powers and duties, its tax-exempt status, or the deductibility of 
contributions to the organization, as set forth in Sec. 53.4945-
2(d)(3);
    (ii) The communication is by a member of an affiliated group of 
organizations (within the meaning of Sec. 56.4911-7(e)), and is an 
appearance before, or communication with, a legislative body with 
respect to a possible action by the body that might affect the existence 
of any other member of the group, its powers and duties, its tax-exempt 
status, or the deductibility of contributions to it;
    (iii) The communication is by an electing public charity more than 
75

[[Page 530]]

percent of the members of which are other organizations that are 
described in section 501(c)(3), and is an appearance before, or 
communication with, any legislative body with respect to a possible 
action by the body which might affect the existence of one or more of 
the section 501(c)(3) member organizations, their powers, duties, or 
tax-exempt status, or the deductibility (under section 170) of 
contributions to one or more of the section 501(c)(3) member 
organizations, but only if the principal purpose of the appearance or 
communication is to defend the section 501(c)(3) member organizations 
(rather than the non-section 501(c)(3) member organizations); or
    (iv) The communication is by an electing public charity that is a 
member of a limited affiliated group or organizations under Sec. 
56.4911-10, and is an appearance before, or communication with, the 
Congress of the United States with respect to a possible action by the 
Congress that might affect the existence of any member of the limited 
affiliated group, its powers and duties, tax-exempt status, or the 
deductibility of contributions to it.
    (v) Under the self-defense exception of paragraphs (c)(4) (i) 
through (iv) of this section, a charity may communicate with an entire 
legislative body, with committees or subcommittees of a legislative 
body, with individual legislators, with legislative staff members, or 
with representatives of the executive branch who are involved with the 
legislative process, so long as such communication is limited to the 
prescribed subjects. Similarly, under the self-defense exception, a 
charity may make expenditures in order to initiate legislation if such 
legislation concerns only matters which might affect the existence of 
the charity, its powers and duties, its tax-exempt status, or the 
deductibility of contributions to such charity. For examples 
illustrating the application and scope of the self-defense exception of 
this paragraph (c)(4), see Sec. 53.4945-2(d)(3)(ii).
    (d) Definitions. For purposes of section 4911 and the regulations 
thereunder--
    (1) Legislation--(i) In general. ``Legislation'' includes action by 
the Congress, any state legislature, any local council, or similar 
legislative body, or by the public in a referendum, ballot initiative, 
constitutional amendment, or similar procedure. ``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.
    (ii) Definition of specific legislation. For purposes of paragraphs 
(b)(1) and (b)(2) of this section, ``specific legislation'' includes 
both legislation that has already been introduced in a legislative body 
and a specific legislative proposal that the organization either 
supports or opposes. In the case of a referendum, ballot initiative, 
constitutional amendment, or other measure that is placed on the ballot 
by petitions signed by a required number or percentage of voters, an 
item becomes ``specific legislation'' when the petition is first 
circulated among voters for signature.
    (iii) Examples. The terms ``legislation'' and ``specific 
legislation'' are illustrated using the following examples:

    Example 1. A nonmembership organization includes in its newsletter 
an article about problems with the use of pesticide X that states in 
part: ``Legislation that is pending in Congress would prohibit the use 
of this very dangerous pesticide. Fortunately, the legislation will 
probably be passed. Write your congressional representatives about this 
important issue.'' This is a grass roots lobbying communication that 
refers to and reflects a view on specific legislation and that 
encourages recipients to take action with respect to that legislation.
    Example 2. An organization based in State A notes in its newsletter 
that State Z has passed a bill to accomplish a stated purpose and then 
says that State A should pass such a bill. The organization urges 
readers to write their legislators in favor of such a bill. No such bill 
has been introduced into the State A legislature. The organization has 
referred to and reflected a view on a specific legislative proposal and 
has also encouraged readers to take action thereon.

    (2) Action. The term ``action'' in paragraph (d)(1)(i) of this 
section is limited to the introduction, amendment, enactment, defeat or 
repeal of Acts, bills, resolutions, or similar items.
    (3) Legislative body. ``Legislative body'' does not include 
executive, judicial, or administrative bodies.

[[Page 531]]

    (4) Administrative bodies. ``Administrative bodies'' includes school 
boards, housing authorities, sewer and water districts, zoning boards, 
and other similar Federal, State, or local special purpose bodies, 
whether elective or appointive. Thus, for example, for purposes of 
section 4911, the term ``any attempt to influence any legislation'' does 
not include attempts to persuade an executive body or department to 
form, support the formation of, or to acquire property to be used for 
the formation or expansion of, a public park or equivalent preserves 
(such as public recreation areas, game, or forest preserves, and soil 
demonstration areas) established or to be established by act of 
Congress, by executive action in accordance with an act of Congress, or 
by a State, municipality or other governmental unit described in section 
170(c)(1), as compared with attempts to persuade a legislative body, a 
member thereof, or other governmental official or employee, to promote 
the appropriation of funds for such an acquisition or other legislative 
authorization of such an acquisition. Therefore, for example, an 
organization would not be influencing legislation for purposes of 
section 4911, if it proposed to a Park Authority that it purchase a 
particular tract of land for a new park, even though such an attempt 
would necessarily require the Park Authority eventually to seek 
appropriations to support a new park. However, in such a case, the 
organization would be influencing legislation, for purposes of section 
4911, if it provided the Park Authority with a proposed budget to be 
submitted to a legislative body, unless such submission is described by 
one of the exceptions set forth in paragraph (c) of this section.



Sec. 56.4911-3  Expenditures for direct and/or grass roots lobbying
communications.

    (a) Definition of term ``expenditures for''--(1) In general. This 
Sec. 56.4911-3 contains allocation rules regarding what portion of a 
lobbying communication's costs is a direct lobbying expenditure, what 
portion is a grass roots expenditure and what portion is, in certain 
cases, a nonlobbying expenditure. Except as otherwise indicated in this 
paragraph (a), all costs of preparing a direct or grass roots lobbying 
communication are included as expenditures for direct or grass roots 
lobbying. Expenditures for a direct or grass roots lobbying 
communication (``lobbying expenditures'') include amounts paid or 
incurred as current or deferred compensation for an employee's services 
attributable to the direct or grass roots lobbying communication, and 
the allocable portion of administrative, overhead, and other general 
expenditures attributable to the direct or grass roots lobbying 
communication. For example, except as otherwise provided in this 
paragraph (a), all expenditures for researching, drafting, reviewing, 
copying, publishing and mailing a direct or grass roots lobbying 
communication, as well as an allocable share of overhead expenses, are 
included as expenditures for direct or grass roots lobbying.
    (2) Allocation of mixed purpose expenditures--(i) Nonmembership 
communications. Except as provided in paragraph (a)(2)(ii) of this 
section, lobbying expenditures for a communication that also has a bona 
fide nonlobbying purpose must include all costs attributable to those 
parts of the communication that are on the same specific subject as the 
lobbying message. All costs attributable to those parts of the 
communication that are not on the same specific subject as the lobbying 
message are not included as lobbying expenditures for allocation 
purposes. Whether or not a portion of a communication is on the same 
specific subject as the lobbying message will depend on the surrounding 
facts and circumstances. In general, a portion of a communication will 
be on the same specific subject as the lobbying message if that portion 
discusses an activity or specific issue that would be directly affected 
by the specific legislation that is the subject of the lobbying message. 
Moreover, discussion of the background or consequences of the specific 
legislation, or discussion of the background or consequences of an 
activity or specific issue affected by the specific legislation, is also 
considered to be on the same specific subject as the lobbying 
communication.

[[Page 532]]

    (ii) Membership communications. In the case of lobbying expenditures 
for a communication that also has a bona fide nonlobbying purpose and 
that is sent only or primarily to members, an electing public charity 
must make a reasonable allocation between the amount expended for the 
lobbying purpose and the amount expended for the nonlobbying purpose. An 
electing public charity that includes as a lobbying expenditure only the 
amount expended for the specific sentence or sentences that encourage 
the recipient to take action with respect to legislation has not made a 
reasonable allocation. For purposes of this paragraph, a communication 
is sent only or primarily to members if more than half of the recipients 
of the communication are members of the electing public charity making 
the communication within the meaning of Sec. 56.4911-5. See Sec. 
56.4911-5 for separate rules on communications sent only or primarily to 
members. Nothing in this paragraph (a) shall change any allocation 
required by Sec. 56.4911-5.
    (3) Allocation of mixed lobbying. If a communication (to which Sec. 
56.4911-5 does not apply) is both a direct lobbying communication and a 
grass roots lobbying communication, the communication will be treated as 
a grass roots lobbying communication except to the extent that the 
electing public charity demonstrates that the communication was made 
primarily for direct lobbying purposes, in which case a reasonable 
allocation shall be made between the direct and the grass roots lobbying 
purposes served by the communication.
    (b) Examples. The provisions of paragraph (a) of this section are 
illustrated by the following examples. Except where otherwise explicitly 
stated, the expenditure test election under section 501(h) is assumed to 
be in effect for all organizations discussed in the examples in this 
paragraph (b). See Sec. 56.4911-5 for special rules applying to the 
member communications described in some of the following examples.

    Example 1. Organization R makes the services of E, one of its paid 
executives, available to S, an organization described in section 
501(c)(4) of the Code. E works for several weeks to assist S in 
developing materials that urge voters to contact their congressional 
representatives to indicate their support for specific legislation. In 
performing this work, E uses office space and clerical assistance 
provided by R. R pays full salary and benefits to E during this period 
and receives no reimbursement from S for these payments or for the other 
facilities and assistance provided. All expenditures of R, including 
allocable office and overhead expenses, that are attributable to this 
assignment are grass roots expenditures because E was engaged in an 
attempt to influence legislation.
    Example 2. An organization distributes primarily to nonmembers a 
pamphlet with two articles on unrelated subjects. The total cost of 
preparing, printing and mailing the pamphlet is $11,000, $1,000 for 
preparation and $10,000 for printing and mailing. The cost of preparing 
one article, a nonlobbying communication, is $600. The article is 
printed on three of the four pages in the pamphlet. The cost of 
preparing the second article, a grassroots lobbying communication that 
addresses only one specific subject, is $400. This article is printed on 
one page of the four page pamphlet. In this situation, $400 of 
preparation costs and $2,500 (25% of $10,000) of printing and mailing 
costs are expenditures for a grass roots lobbying communication.
    Example 3. Assume the same facts as in Example (2), except that the 
pamphlet is distributed only to members. In addition, assume the second 
article states that the recipient members should contact their 
congressional representatives. The organization allocates $400 of 
preparation costs and $2,500 of printing and mailing costs as 
expenditures for direct lobbying (see Sec. 56.4911-5(c)). The 
allocation is reasonable for purposes of Sec. 56.4911-3(a)(2)(ii).
    Example 4. Organization J places a full-page advertisement in a 
newspaper. The advertisement urges passage of pending legislation to 
build three additional nuclear powered submarines, and states that 
readers should write their Congressional representatives in favor of the 
legislation. The advertisement also provides a general description of 
J's purposes and activities, invites readers to become members of J and 
asks readers to contribute money to J. Except for the cost of the 
portion of the advertisement describing J's purposes and activities and 
the portion specifically seeking members and contributions, the entire 
cost of the advertisement is an expenditure for a grass roots lobbying 
communication, because the entire advertisement, except for the lines 
specifically describing J and specifically seeking members and 
contributions, is on the same specific subject as the grass roots 
lobbying message.
    Example 5. Assume the same facts as in Example (4), except that J 
places in the newspaper two separate half-page advertisements instead of 
one full-page advertisement. One of the two advertisements discusses the 
need for three additional nuclear powered submarines and urges readers 
to write their

[[Page 533]]

Congressional representatives in favor of the pending legislation to 
build the three submarines. The other advertisement contains only the 
membership and fundraising appeals, along with a general description of 
J's purposes and activities. The half-page advertisement urging readers 
to write to Congress is a grass roots lobbying communication and all of 
J's expenditures for producing and placing that advertisement are 
expenditures for a grass roots lobbying communication. J's expenditures 
for the other half-page advertisement are not expenditures for a grass 
roots or direct lobbying communication.
    Example 6. Assume the same facts as in Example (4), except that the 
communication by J is in a letter mailed only to members of J, rather 
than in newspaper advertisement, and the invitation to become a member 
of J is an invitation to join a new membership category. In addition, 
assume that the communication states that the member recipients should 
ask nonmembers to write their Congressional representatives. J allocates 
one-half of the cost of the mailing as an expenditure for a grass roots 
lobbying communication (see Sec. 56.4911-5(d)). Because the 
communication had both bona fide nonlobbying (e.g., membership 
solicitation and fundraising) purposes as well as lobbying purposes, J's 
allocation of one-half of the cost of the communication to grass roots 
lobbying and one-half to nonlobbying is reasonable for purposes of Sec. 
56.4911-3(a)(2)(ii).
    Example 7. A particular monthly issue of organization X's 
newsletter, which is distributed mainly to nonmembers of X, has three 
articles of equal length. The first article is a grass roots lobbying 
communication, the sole specific subject of which is pending legislation 
to help protect seals from being slaughtered in certain foreign 
countries. The second article discusses the rapid decline in the world's 
whale population, particularly because of the illegal hunting of whales 
by foreign countries. The third article deals with air pollution and the 
acid rain problem in North America. Because the first article is a grass 
roots lobbying communication, all of the costs allocable to that article 
(e.g., one-third of the newsletter's printing and mailing costs) are 
lobbying expenditures. The second article is not a lobbying 
communication and the pending legislation relating to seals addressed in 
the first article does not affect the illegal whale hunting activities. 
Because the second and third articles are not lobbying communications 
and are also not on the same specific subject as the first article, no 
portion of the costs attributable to those articles is a grass roots 
lobbying expenditure.
    Example 8. Organization T, a nonmembership organization, prepares a 
three page document that is mailed to 3,000 persons on T's mailing list. 
The first two pages of the three page document, titled ``The Need for 
Child Care,'' support the need for additional child care programs, and 
include statistics on the number of children living in homes where both 
parents work or in homes with a single parent. The two pages also make 
note of the inadequacy of the number of day care providers to meet the 
needs of these parents. The third page of the document, titled ``H.R. 
1,'' indicates T's support of H.R. 1, a bill pending in the U.S. House 
of Representatives. The document states that H.R. 1 will provide for 
$10,000,000 in additional subsidies to child care providers, primarily 
for those providers caring for lower income children. The third page of 
the document also notes that H.R. 1 includes new federal standards 
regulating the quality of child care providers. The document ends with 
T's request that recipients contact their congressional representative 
in support of H.R. 1. The entire three page document is on the same 
specific subject, and, therefore, all expenditures of preparing and 
distributing the three page document are grass roots lobbying 
expenditures.
    Example 9. Assume the same facts as in Example (8), except that the 
document has a fourth page. The fourth page does not refer to the 
general need for child care or the specific need for additional child 
care providers. Instead, the fourth page advocates that a particular 
federal agency commence, under its existing statutory authority, 
licensing of day care providers in order to promote safe and effective 
child care. The cost of the fourth page is not a lobbying expenditure.
    Example 10. Assume the same facts as in Example (8), except that T 
is a membership organization, 75 percent of the recipients of the three 
page document are members of T, and 25 percent of the recipients are 
nonmembers and are not subscribers within the meaning of Sec. 56.4911-
5(f)(5). Assume also that the document states that readers should write 
to Congress, but does not state that the readers should urge nonmembers 
to write to Congress. T treats the document as having a bona fide 
nonlobbying purpose, the purpose of educating its members about the need 
for child care. Accordingly, T allocates one-half of the cost of 
preparing and distributing the document as a lobbying expenditure (see 
Sec. 56.4911-5(e)(2)(i)), of which 75 percent is a direct lobbying 
expenditure (see Sec. 56.4911-5(e)(2)(iii)) and 25 percent is a grass 
roots lobbying expenditure (see Sec. 56.4911-5(e)(2)(ii)). The 
remaining one-half is allocated as a nonlobbying expenditure. T's 
allocation is reasonable for purposes of Sec. 56.4911-3(a)(2)(ii) and 
is correct for purposes of Sec. 56.4911-5(e).
    Example 11. Assume the same facts as in Example (10), except that T 
allocates one percent of the cost of preparing and distributing the 
document as a lobbying expenditure (for purposes of Sec. 56.4911-
5(e)(2)) and 99

[[Page 534]]

percent as a nonlobbying expenditure. T's allocation is based upon the 
fact that out of 200 lines in the document, only two lines state that 
the recipient should contact legislators about the pending legislation. 
T's allocation is unreasonable for purposes of Sec. 56.4911-
3(a)(2)(ii).
    Example 12. Organization F, a nonmembership organization, sends a 
one page letter to all persons on its mailing list. The only subject of 
the letter is the organization's opposition to a pending bill allowing 
private uses of certain national parks. The letter requests recipients 
to send letters opposing the bill to their congressional 
representatives. A second one page letter is sent in the same envelope. 
The second letter discusses the broad educational activities and 
publications of the organization in all areas of environmental 
protection and ends by requesting the recipient to make a financial 
contribution to organization F. Since the separate second letter is on a 
different subject from the lobbying letter, and the letters are of equal 
length, 50 percent of the mailing costs must be allocated as an 
expenditure for a grass roots lobbying communication.
    Example 13. Assume the same facts as in Example (12), except that F 
is a membership organization and the letters in question are sent 
primarily (90 percent) to members. The other 10 percent of the 
recipients are nonmembers and are not subscribers within the meaning of 
Sec. 56.4911-5(f)(5). Assume also that the first letter does not state 
that readers should urge nonmembers to write to legislators. F allocates 
one-half of the mailing costs as a lobbying expenditure, of which 90 
percent is a direct lobbying expenditure and 10 percent is a grass roots 
lobbying expenditure (see Sec. 56.4911-5(e)(2)). F's allocation is 
reasonable for purposes of Sec. 56.4911-3(a)(2)(ii) and is correct for 
purposes of Sec. 56.4911-5.

    (c) Certain transfers treated as lobbying expenditures--(1) Transfer 
earmarked for grass roots purposes. A transfer is a grass roots 
expenditure to the extent that it is earmarked (as defined in Sec. 
56.4911-4(f)(4)) for grass roots lobbying purposes and is not described 
in Sec. 56.4911-4(e).
    (2) Transfer earmarked for direct and grass roots lobbying. A 
transfer that is earmarked for direct lobbying purposes or for direct 
lobbying and grass roots lobbying purposes is treated as a grass roots 
expenditure in full except to the extent the transferor demonstrates 
that all or part of the amounts transferred were expended for direct 
lobbying purposes, in which case that part of the amounts transferred is 
a direct lobbying expenditure by the transferor. This paragraph (c)(2) 
shall not apply to any expenditure described in Sec. 56.4911-4(e).
    (3) Certain transfers to noncharities that lobby--(i) Limited 
application of paragraph (c)(3)--(A) In general. This paragraph (c)(3) 
applies only to transfers for less than fair market value from an 
electing public charity to any noncharity that makes lobbying 
expenditures. A noncharity is any entity that is not described in 
section 501(c)(3). In order for this paragraph to apply, the electing 
public charity must transfer to a noncharity more in value than it 
receives in return. For example, this paragraph does not apply to an 
electing public charity's fair market value payment of rent to a 
landlord. However, this paragraph does apply where an electing public 
charity and a noncharity share office space and the electing public 
charity pays more than fair market value rent to the noncharity. 
Similarly, this paragraph applies where an electing public charity sells 
goods or services to a noncharity for less than fair market value. See 
paragraphs (c)(3)(i) (B), (C) and (D) of this section for exceptions 
where non-fair market value transfers are not covered by this paragraph 
(c)(3). See paragraph (c)(3)(i)(E) of this section to determine the 
amount of any non-fair market value transfer covered by this paragraph 
(c)(3). See paragraph (c)(3)(ii) of this section for the rules that 
apply to transfers governed by this paragraph (c)(3).
    (B) Exception for controlled grants. Notwithstanding paragraph 
(c)(3)(i)(A) of this section, this paragraph (c)(3) does not apply where 
an electing public charity makes a grant to a noncharity that is a 
controlled grant (as defined in Sec. 56.4911-4(f)(3)).
    (C) Exception for transfers that artificially inflate exempt purpose 
expenditures. Notwithstanding paragraph (c)(3)(i)(A) of this section, 
this paragraph (c)(3) does not apply where an electing public charity 
makes a grant to a noncharity that is an expenditure described in Sec. 
56.4911-4(e) (relating to grants that artificially inflate exempt 
purpose expenditures).
    (D) Exception for substantially related activity. Notwithstanding 
paragraph (c)(3)(i)(A) of this section, this paragraph (c)(3) does not 
apply where an

[[Page 535]]

electing public charity, in the course of an activity that is 
substantially related to the accomplishment of the electing public 
charity's exempt purposes, makes goods or services widely available for 
less than fair market value to individual members of the general public 
and those goods or services are actually purchased (or consumed for no 
charge) by a substantial number of wholly unrelated individual members 
of the general public for less than fair market value. For purposes of 
the preceding sentence, the term ``individual member of the general 
public'' does not include any person or entity directly or indirectly 
affiliated with the electing public charity in question. The following 
example illustrates this paragraph (c)(3)(i)(D):

    Example. Organization P is an educational organization dedicated to 
preserving the environment. One of P's activities is educating the 
public about the benefits of installing cost-effective passive solar 
energy systems, thereby helping to preserve the environment. P charges 
for its extensive literature and advice, but the charges are less than 
the fair market value of the literature and advice. P makes its 
literature and advice widely available to individual members of the 
general public by advertising in various media and by pamphlets 
distributed in various areas. P annually provides its literature and 
advice for less than fair market value to 500 wholly unrelated families, 
businesses, and tax-exempt organizations. Several of the businesses and 
tax-exempt organizations make lobbying expenditures within the meaning 
of section 4911. P's provision of its goods and services to these 
entities is not covered by this paragraph (c)(3) (and thus does not give 
rise to a lobbying expenditure by P under paragraph (c)(3)(ii)).

    (E) Determination of amount of transfer governed by paragraph 
(c)(3). Where an electing public charity receives nothing of value in 
return for its transfer, the amount of the transfer governed by this 
paragraph (c)(3) is the greater of the fair market value or the cost of 
the goods or services transferred to the noncharity. Where the 
noncharity transfers something of value to the electing public charity 
in return for the charity's transfer, but that payment is less than the 
fair market value of the charity's transfer to the noncharity, the 
amount of the transfer governed by this paragraph (c)(3) is the excess 
of: first, the greater of the fair market value or cost of the goods or 
services transferred to the noncharity over, second, the value of the 
amount transferred to the charity. For example, if an electing public 
charity transfers $10,000 of goods and services to a noncharity that 
makes lobbying expenditures in return for payment by the noncharity of 
$2,000, the amount of the transfer governed by this paragraph (c)(3) is 
$8,000.
    (ii) Rules governing transfers to which paragraph (c)(3) applies. A 
transfer to which this paragraph (c)(3) applies is treated in whole or 
in part as a grass roots and/or direct lobbying expenditure by the 
transferor in accordance with paragraphs (c)(3)(ii) (A), (B) and (C) of 
this section. In applying those paragraphs, the expenditures of the 
transferee will be determined as if the regulations under section 4911 
applied to the transferee. This paragraph (c)(3) discusses only when 
certain transfers are lobbying expenditures by the transferor. This 
paragraph does not address other issues that may arise when an electing 
public charity makes a noncontrolled grant to a noncharity. Nothing in 
this paragraph (c)(3) shall be used to interpret issues relating to 
noncontrolled grants by charities to noncharities, such as whether the 
noncontrolled grant is consistent with the continued tax-exempt status 
of the electing public charity.
    (A) Transfers treated as grass roots expenditures. The transfer is 
treated as a grass roots expenditure to the extent of the lesser of two 
amounts: The amount of the transfer and the amount of the transferee's 
grass roots expenditures.
    (B) Transfers treated as direct lobbying expenditures. If the 
transfer is greater than the transferee's grass roots expenditures, the 
excess is treated as a direct lobbying expenditure, but only to the 
extent of the transferee's direct lobbying expenditures. (If, however, 
the transfer is less than the transferee's grass roots expenditures, 
none of the transfer is a direct lobbying expenditure.)
    (C) Transfers treated as nonlobbying. If the transfer is greater 
than the sum of the transferee's grass roots and direct lobbying 
expenditures, the excess of the transfer over those lobbying expenses is 
not a lobbying expenditure.

[[Page 536]]

    (iii) Example. The following example illustrates the application of 
this paragraph (c)(3):

    Example. Organization C, an electing public charity, shares employee 
E with N, a noncharity that makes lobbying expenditures. N's grass roots 
expenditures are $5,000 and its direct lobbying expenditures are 
$25,000. Each organization pays one-half of the $100,000 in direct and 
overhead costs associated with E. E devotes one-quarter of his time to C 
and three-quarters of his time to N. In substance, this arrangement is a 
transfer (for less than fair market value) from C to N in the amount of 
$25,000 (one-quarter of the $100,000 of direct and overhead costs 
associated with E's work). Accordingly, C is treated as having made a 
$5,000 grass roots expenditure (the lesser of N's grass roots 
expenditures ($5,000) or the amount of the transfer ($25,000)). C is 
also treated as having made a $20,000 direct lobbying expenditure (the 
lesser of N's direct lobbying expenditures ($25,000) or the remaining 
amount of the transfer ($20,000)).



Sec. 56.4911-4  Exempt purpose expenditures.

    (a) Application. This section provides rules under section 4911(e) 
for determining an electing public charity's ``exempt purpose 
expenditures'' for a taxable year for purposes of section 4911(c)(2) and 
Sec. 56.4911-1(c)(2). Those two sections generally define an electing 
public charity's lobbying limit (lobbying nontaxable amount) as a 
sliding scale percentage of the organization's exempt purpose 
expenditures. In determining an electing public charity's exempt purpose 
expenditures, no expenditure shall be counted twice by an organization.
    (b) Included expenditures. Amounts paid or incurred by an 
organization that are exempt purpose expenditures include--
    (1) Amounts paid or incurred to accomplish a purpose enumerated in 
section 170(c)(2)(B), including (but not limited to) the amount of any 
transfer made by the organization (other than a transfer described in 
paragraph (e) of this section) to another organization to accomplish the 
transferor's exempt purposes, and including amounts expended by an 
organization out of transfers (other than a transfer described in 
paragraph (e) of this section) for which the organization is the 
transferee,
    (2) Amounts paid or incurred as current or deferred compensation for 
an employee's services for a purpose enumerated in section 170(c)(2)(B),
    (3) The allocable portion of administrative overhead, and other 
general expenditures attributable to the accomplishment of a purpose 
enumerated in section 170(c)(2)(B),
    (4) Lobbying expenditures (as defined in Sec. 56.4911-2(a)) whether 
or not for a purpose enumerated in section 170(c)(2)(B),
    (5) Amounts paid or incurred for activities described in Sec. 
56.4911-2(c),
    (6) Amounts paid or incurred for activities described in Sec. 
56.4811-5 that are not lobbying expenditures,
    (7) A reasonable allowance for exhaustion, wear and tear, 
obsolescence or amortization, of assets to the extent used for one or 
more of the purposes described in paragraphs (b)(1) through (6) of this 
section, computed on a straight-line basis (for this purpose, an 
allowance for depreciation will be treated as reasonable if based on a 
useful life that would satisfy section 321(k)(3)(A) as in effect on 
January 1, 1985), and
    (8) Fundraising expenditures (but see section 4911(e)(1)(C) and 
paragraphs (c)(3) and (4) of this section.)
    (c) Excluded expenditures. Notwithstanding paragraph (b) of this 
section, exempt purpose expenditures do not include--
    (1) Amounts paid or incurred that are neither expenditures to 
accomplish a purpose enumerated in section 170(c)(2)(B), lobbying 
expenditures (as defined in Sec. 56.4911-2(a)), nor expenditures 
described in paragraph (b)(5), (6) or (8) of this section,
    (2) The amounts of any transfer described in paragraph (e) of this 
section,
    (3) Amounts paid to or incurred for a separate fundraising unit (as 
defined in paragraph (f)(2) of this section) of an organization or of an 
affiliated organization (see Sec. 56.4911-7(a)),
    (4) Amounts paid to or incurred for any person not an employee, or 
any organization not an affiliated organization, if paid or incurred 
primarily for fundraising, but only if such person or organization 
engages in fundraising, fundraising counselling or the provision of 
similar advice or services,

[[Page 537]]

    (5) Amounts paid or incurred that are properly chargeable to a 
capital account, determined in accordance with the principles that apply 
under section 263 or, as applicable, section 263A, with respect to an 
unrelated trade or business,
    (6) Amounts paid or incurred for a tax that is not imposed in 
connection with the organization's efforts to accomplish a purpose 
described in section 170(c)(2)(B), such as taxes imposed under sections 
511(a)(1) and 4911(a), and
    (7) Amounts paid or incurred for the production of income. For 
purposes of this section, amounts are paid or incurred for the 
production of income if they are paid or incurred for a purpose or 
activity that is not substantially related (aside from the need of the 
organization for income or funds or the use it makes of the profits 
derived) to the exercise or performance by the organization of its 
charitable, educational or other purpose or function constituting the 
basis for its exemption under section 501. For example, the costs of 
managing an endowment are amounts that are paid or incurred for the 
production of income and are thus not exempt purpose expenditures. 
Fundraising expenditures are not, for purposes of this section, amounts 
that are paid or incurred for the production of income. Instead, the 
determination of whether fundraising costs are exempt purpose 
expenditures must be made with reference to section 4911(e)(1)(C) and 
paragraphs (b)(8), (c)(3) and (c)(4) of this section.
    (d) Certain transfers treated as exempt purpose expenditures--(1) An 
organization's transfer will be treated as an exempt purpose expenditure 
under paragraph (b)(1) of this section if it is--
    (i) Described in either paragraph (d)(2) or (d)(3) of this section, 
and
    (ii) Not described in paragraph (e) of this section.
    (2) A transfer is described in this paragraph (d)(2) if it is made 
to an organization described in section 501(c)(3) in furtherance of the 
transferor's exempt purposes and is not earmarked for any purpose other 
than a purpose described in section 170(c)(2)(B). Thus, a payment of 
dues by a local or state organization to, respectively, a state or 
national organization that is described in section 501(c)(3) is 
considered an exempt purpose expenditure of the transferor to the extent 
it is not otherwise earmarked.
    (3) A transfer is described in this paragraph (d)(3) if it is a 
controlled grant (as defined in paragraph (f)(3) of this section), but 
only to the extent of the amounts that are paid or incurred by the 
transferee that would be exempt purpose expenditures if paid or incurred 
by the transferor.
    (e) Transfers not exempt purpose expenditures--(1) An organization's 
transfer is described in this paragraph (e) if it is described in one of 
paragraphs (e)(2) through (e)(4).
    (2) A transfer is described in this paragraph (e)(2) if it is made 
to a member of any affiliated group (as defined in Sec. 56.4911-7(e)) 
of which the transferor is a member.
    (3) A transfer is described in this paragraph (e)(3) if the 
Commissioner determines that the transfer artificially inflates the 
amount of the transferor's or transferee's exempt purpose expenditures. 
In general, the Commissioner will make that determination if a 
substantial purpose of a transfer is to inflate those exempt purpose 
expenditures. A transfer described in this paragraph will not be 
considered an exempt purpose expenditure of the transferor, but will be 
an exempt purpose expenditure of the transferee to the extent that the 
transferee expends the transfer in the active conduct of its charitable 
activities or attempts to influence legislation. Standards similar to 
those found in Sec. 53.4942(b)-1(b) may be applied in determining 
whether the transferee has expended amounts in the ``active conduct'' of 
its charitable activities or attempts to influence legislation.
    (4) A transfer is described in this paragraph (e)(4) if it is not a 
controlled grant and is made to an organization not described in section 
501(c)(3) that does not attempt to influence legislation.
    (f) Definitions--(1) For purposes of paragraph (c) of this section, 
``fundraising'' includes--
    (i) Soliciting dues or contributions from members of the 
organization, from persons whose dues are in arrears, or from the 
general public,

[[Page 538]]

    (ii) Soliciting grants from businesses or other organizations, 
including organizations described in section 501(c)(3), or
    (iii) Soliciting grants from a governmental unit referred to in 
section 170(c)(1), or any agency or instrumentality thereof.
    (2) For purposes of paragraph (c) of this section, a separate 
fundraising unit of any organization must consist of either two or more 
individuals a majority of whose time is spent on fundraising for the 
organization, or any separate accounting unit of the organization that 
is devoted to fundraising. For purposes of paragraph (c) of this 
section, amounts paid to or incurred for a separate fundraising unit 
include all amounts incurred for the creation, production, copying, and 
distribution of the fundraising portion of a separate fundraising unit's 
communication. (For example, an electing public charity that has a 
separate fundraising unit may not count the cost of postage for a 
separate fundraising unit's communication as an exempt purpose 
expenditure even though, under the electing public charity's accounting 
system, that cost is attributable to the mailroom rather than to the 
separate fundraising unit.)
    (3) For purposes of this section, a ``controlled grant'' is a grant 
made by an eligible organization described in Sec. 1.501(h)-2(b) to an 
organization not described in section 501(c)(3) that meets the following 
requirements:
    (i) The donor limits the grant to a specific project of the 
recipient that is in furtherance of the donor's (nonlobbying) exempt 
purposes; and
    (ii) The donor maintains records to establish that the grant is used 
in furtherance of the donor's (nonlobbying) exempt purposes.
    (4) A transfer, including a grant or payment of dues, is 
``earmarked'' for a specific purpose--
    (i) To the extent that the transferor directs the transferee to add 
the amount transferred to a fund established to accomplish the purpose, 
or
    (ii) To the extent of the amount transferred or, if less, the amount 
agreed upon to the expended to accomplish the purpose, if there exists 
an agreement, oral or written, whereby the transferor may cause the 
transferee to expend amounts to accomplish the purpose or whereby the 
transferee agrees to expend an amount to accomplish the purpose.
    (g) Example. The provisions of this section are illustrated by the 
following example:

    Example. Organization X is an exempt organization described in 
section 501(c)(3) that is organized for the purpose of rehabilitating 
alcoholics. X elected to be subject to the provisions of section 501(h) 
in 1981. For 1981, X had the following expenditures that are included in 
its exempt purpose expenditures to the extent indicated.

------------------------------------------------------------------------
                                               Total        Includible
               Description                   (dollars)       (dollars)
------------------------------------------------------------------------
Cost of real estate purchased for use as
 half-way house for alcoholics,
 attributable to the following:
    Land................................          30,000  ..............
    Building............................         200,000  ..............
    Depreciation 40-year useful life....  ..............           5,000
Expenses of operating its half-way house         170,000         170,000
Administrative expenses of the                    95,000          95,000
 organization allocated to the operation
 of its half-way house..................
Depreciation and allowances for                   10,000          10,000
 equipment..............................
Expenses related to attempts to                   40,000          40,000
 influence legislation (lobbying
 expenditures)..........................
Amounts paid to Z by the Organization             35,000  ..............
 for fundraising........................
                                         -------------------------------
      Total.............................         580,000         320,000
------------------------------------------------------------------------

    Note: For 1981, X's exempt purpose expenditures total $320,000. The 
$35,000 paid by X to Z for fundraising is not included in the exempt 
purpose expenditures total. All lobbying expenses are included in full. 
Only depreciation computed on a straight-line basis is included in 
exempt purpose expenditures.



Sec. 56.4911-5  Communications with members.

    (a) In general. For purposes of section 4911, expenditures for 
certain communications between an organization and

[[Page 539]]

its members (``membership communications'') are treated more leniently 
than are communications to nonmembers. This Sec. 56.4911-5 contains 
rules about the more lenient treatment. In certain cases, this section 
provides that expenditures for a membership communication are not 
lobbying expenditures even though those expenditures would be lobbying 
expenditures if the communication were to nonmembers. In other cases, 
this section provides that expenditures for a membership communication 
are direct lobbying expenditures even though those expenditures would be 
grass roots expenditures if the communication were to nonmembers. 
Paragraphs (b), (c) and (d) of this section set forth the more lenient 
rules that apply for communications that are directed only to members. 
Paragraph (e) of this section sets forth the more lenient rules that 
apply for communications that are directed primarily, but not solely, to 
members. Paragraph (f) of this section sets forth certain definitions 
and special rules.
    (b) Communications (directed only to members) that are not lobbying 
communications. Expenditures for a communication that refers to, and 
reflects a view on, specific legislation are not lobbying expenditures 
if the communication satisfies the following requirements:
    (1) The communication is directed only to members of the 
organization;
    (2) The specific legislation the communication refers to, and 
reflects a view on, is of direct interest to the organization and its 
members;
    (3) The communication does not directly encourage the member to 
engage in direct lobbying (whether individually or through the 
organization); and
    (4) The communication does not directly encourage the member to 
engage in grass roots lobbying (whether individually or through the 
organization).
    (c) Communications (directed only to members) that are direct 
lobbying communications. Expenditures for a communication that refers 
to, and reflects a view on, specific legislation and that satisfies the 
requirements of paragraphs (b)(1), (b)(2), and (b)(4) of this section, 
but does not satisfy the requirements of paragraph (b)(3) of this 
section, are treated as expenditures for direct lobbying.
    (d) Communications (directed only to members) that are grass roots 
lobbying communications. Expenditures for a communication that refers 
to, and reflects a view on, specific legislation and that satisfies the 
requirements of paragraphs (b)(1) and (b)(2) of this section, but does 
not satisfy the requirements of paragraph (b)(4) of this section, are 
treated as grass roots expenditures (whether or not the communication 
satisfies the requirements of paragraph (b)(3) of this section).
    (e) Written communications directed to members and nonmembers--(1) 
In general. Expenditures for any written communication that is designed 
primarily for members of an organization (but not directed only to 
members) and that refers to, and reflects a view on, specific 
legislation of direct interest to the organization and its members, are 
treated as expenditures for direct or grass roots lobbying in accordance 
with paragraph (e)(2), (e)(3) or (e)(4) of this section. For purposes of 
this section, a communication is designed primarily for members of an 
organization if more than half of the recipients of the communication 
are members of the organization.
    (2) Direct lobbying directly encouraged--(i) Lobbying expenditure 
amount. If a written communication described in paragraph (e)(1) of this 
section directly encourages readers to engage individually or through 
the organization in direct lobbying but does not directly encourage them 
to engage in grass roots lobbying, the cost of the communication is 
allocated between expenditures for direct lobbying and grass roots 
expenditures in accordance with paragraphs (e)(2) (ii) and (iii) of this 
section. The portion of the cost to be allocated includes all costs of 
preparing all the material with respect to which readers are urged to 
engage in direct lobbying plus the mechanical and distribution costs 
attributable to the lineage devoted to this material (see Sec. 
1.512(a)-1(f)(6)).
    (ii) Grass roots amount. The amount allocable as a grass roots 
expenditure for a communication described in paragraph (e)(1) of this 
section is the amount calculated in paragraph

[[Page 540]]

(e)(2)(i) of this section multiplied by the sum of the nonmember 
subscribers percentage and all the other distribution percentage, both 
as defined in paragraph (f)(7) of this section. Solely for purposes of 
the allocation described in this paragraph (e)(2)(ii), the nonmember 
subscribers percentage is treated as zero unless it is greater than 15% 
of total distribution.
    (iii) Direct lobbying amount. The amount allocable as an expenditure 
for direct lobbying for a communication described in paragraph (e)(1) of 
this section is the excess of the amount described in paragraph 
(e)(2)(i) of this section over the amount described in paragraph 
(e)(2)(ii) of this section.
    (3) Grass roots expenditure if grass roots lobbying directly 
encouraged. If a written communication described in paragraph (e)(1) of 
this section directly encourages readers to engage individually or 
collectively (whether through the organization or otherwise) in grass 
roots lobbying (whether or not it also encourages readers to engage in 
direct lobbying), the grass roots expenditure includes all the costs of 
preparing all the material with respect to which readers are urged to 
engage in grass roots lobbying plus the mechanical and distribution 
costs attributable to the lineage devoted to this material (see Sec. 
1.512(a)-1(f)(6)).
    (4) No direct encouragement of direct lobbying or of grass roots 
lobbying. If a written communication described in paragraph (e)(1) of 
this section does not directly encourage readers to engage in either 
direct lobbying or grass roots lobbying, expenditures for the 
communication are not lobbying expenditures.
    (f) Definitions and special rules. For purposes of the regulations 
under section 4911--
    (1) Member; general rule. A person is a member of an electing public 
charity if the person--
    (i) Pays dues or makes a contribution of more than a nominal amount,
    (ii) Makes a contribution of more than a nominal amount of time, or
    (iii) Is one of a limited number of ``honorary'' or ``life'' members 
who have more than a nominal connection with the electing public charity 
and who have been chosen for a valid reason (such as length of service 
to the organization or involvement in activities forming the basis of 
the electing public charity's exemption) unrelated to the electing 
public charity's dissemination of information to its members.
    (2) Member; special rule. A person not a member of an electing 
public charity within the meaning of paragraph (f)(1) of this section 
may be treated as a member if the electing public charity demonstrates 
to the satisfaction of the Internal Revenue Service that there is a good 
reason for its membership requirements not meeting the requirements of 
such paragraph (f)(1), and that its membership requirements do not 
operate to permit an abuse of the rules described in this section.
    (3) Member; affiliated group of organizations. For purposes of this 
section, a person who is a member of an organization that is a member of 
an affiliated group of organizations (within the meaning of Sec. 
56.4911-7(e)) is treated as a member of each organization in the 
affiliated group.
    (4) Member; limited afffiliated group of organizations. For purposes 
of this section, a person who is a member of an organization that is a 
member of a limited affiliated group of organizations (within the 
meaning of Sec. 56.4911-10(b)) is treated as a member of each 
organization in the limited affiliated group, but only to the extent 
that the communication relates to a national legislative issue (within 
the meaning of Sec. 56.4911-10(g)).
    (5) Subscriber. A person is a subscriber to a written communication 
if--
    (i) The person is a member of the publishing organization and the 
membership dues expressly include the right to receive the written 
communication, or
    (ii) The person has affirmatively expressed a desire to receive the 
written communication and has paid more than a nominal amount of the 
communication.
    (6) Directly encourages--(i) Direct lobbying--(A) In general. For 
purposes of this section, a communication directly encourages a 
recipient to engage in direct lobbying, whether individually or through 
the organization, if the communication:
    (1) States that the recipient should contact a legislator or an 
employee of

[[Page 541]]

a legislative body, or should contact any other government official or 
employee who may participate in the formulation of legislation (but only 
if the principal purpose of urging contact with the government official 
or employee is to influence legislation);
    (2) States the address, telephone number, or similar information of 
a legislator or an employee of a legislative body; or
    (3) Provides a petition, tear-off postcard or similar material for 
the recipient to communicate his or her views to a legislator or an 
employee of a legislative body, or to any other government official or 
employee who may participate in the formulation of legislation (but only 
if the principal purpose of so facilitating contact with the government 
official or employee is to influence legislation).
    (B) ``Self-defense'' exception for communications with members. 
Notwithstanding the provisions of paragraph (f)(6)(i)(A) of this 
section, for purposes of paragraphs (b)(3), (e)(2)(i), (e)(3) and (e)(4) 
of this section, a communication that directly encourages a member to 
engage in direct lobbying activities that are described in section 
4911(d)(2)(C) and that would not be attempts to influence legislation if 
engaged in directly by the organization is treated as a communication 
that does not directly encourage a member to engage in direct lobbying.
    (ii) Grass roots lobbying. For purposes of paragraphs (b)(4), (e)(3) 
and (e)(4) of this section, a communication directly encourages 
recipients to engage individually or collectively (whether through the 
organization or otherwise) in grass roots lobbying if the communication:
    (A) States that the recipient should encourage any nonmember to 
contact a legislator or an employee of a legislative body, or to contact 
any other government official or employee who may participate in the 
formulation of legislation (but only if the principal purpose of urging 
contact with the government official or employee is to influence 
legislation);
    (B) States that the recipient should provide to any nonmember the 
address, telephone number, or similar information of a legislator or an 
employee of a legislative body; or
    (C) Provides (or requests that the recipient provide to nonmembers) 
a petition, tear-off postcard or similar material for the recipient (or 
nonmember) to use to ask any nonmember to communicate views to a 
legislator or an employee of a legislative body, or to any other 
government official or employee who may participate in the formulation 
of legislation, but only if the principal purpose of so facilitating 
contact with the government official or employee is to influence 
legislation. For purposes of this paragraph (f)(6)(ii)(C), a petition is 
provided for the recipient to use to ask any nonmember to communicate 
views if, for example, the petition has an entire page of preprinted 
signature blocks. Similarly, for purposes of this paragraph 
(f)(6)(ii)(C), where a communication is distributed to a single member 
and provides several tear-off postcards addressed to a legislator, the 
postcards are presumed to be provided for the member to use to ask a 
nonmember to communicate with the legislator.
    (7) Percentages of total distribution. With respect to a 
communication described in paragraph (e)(1) of this section--
    (i) ``Member percentage'' means the percentage of total distribution 
that represents distribution of a single copy to any member;
    (ii) ``Nonmember subscribers percentage'' means the percentage of 
total distribution that represents distribution to nonmember subscribers 
(including libraries); and
    (iii) ``All other distribution percentage'' means 100% reduced by 
the sum of the member percentage and the nonmember subscribers 
percentage.
    (8) Reasonable allocation rule. In the case of lobbying expenditures 
for a communication that also has a bona fide nonlobbying purpose and 
that is sent only or primarily to members, an electing public charity 
must make a reasonable allocation between the amount expended for the 
lobbying purpose and the amount expended for the nonlobbying purpose. 
See Sec. 56.4911-3(a)(2)(ii).

[[Page 542]]



Sec. 56.4911-6  Records of lobbying and grass roots expenditures.

    (a) Records of lobbying expenditures. An electing public charity 
must keep a record of its lobbying expenditures for the taxable year. 
Lobbying expenditures of which an organization must keep a record 
include the following:
    (1) Expenditures for grass roots lobbying, as described in paragraph 
(b) of this section;
    (2) Amounts directly paid or incurred for direct lobbying, including 
payments to another organization earmarked for direct lobbying, fees and 
expenses paid to individuals or organizations for direct lobbying, and 
printing, mailing, and other direct costs of reproducing and 
distributing materials used in direct lobbying;
    (3) The portion of amounts paid or incurred as current or deferred 
compensation for an employee's services for direct lobbying;
    (4) Amounts paid for out-of-pocket expenditures incurred on behalf 
of the organization and for direct lobbying, whether or not incurred by 
an employee;
    (5) The allocable portion of administrative, overhead, and other 
general expenditures attributable to direct lobbying;
    (6) Expenditures for publications or for communications with members 
to the extent the expenditures are treated as expenditures for direct 
lobbying under Sec. 56.4911-5; and
    (7) Expenditures for direct lobbying of a controlled organization 
(within the meaning of Sec. 56.4911-10(c)) to the extent included by a 
controlling organization (within the meaning of Sec. 56.4911-10(c)) in 
its lobbying expenditures.
    (b) Records of grass roots expenditures. An electing public charity 
must keep a record of its grass roots expenditures for the taxable year. 
Grass roots expenditures of which an organization must keep a record 
include the following:
    (1) Amounts directly paid or incurred for grass roots lobbying, 
including payments to other organizations earmarked for grass roots 
lobbying, fees and expenses paid to individuals or organizations for 
grass roots lobbying, and the printing, mailing, and other direct costs 
of reproducing and distributing materials used in grass roots lobbying;
    (2) The portion of amounts paid or incurred as current or deferred 
compensation for an employee's services for grass roots lobbying;
    (3) Amounts paid for out-of-pocket expenditures incurred on behalf 
of the organization and for grass roots lobbying, whether or not 
incurred by an employee;
    (4) The allocable portion of administrative, overhead and other 
general expenditures attributable to grass roots lobbying;
    (5) Expenditures for publication or communications that are treated 
as expenditures for grass roots lobbying under Sec. 56.4911-5; and
    (6) Expenditures for grass roots lobbying of a controlled 
organization (within the meaning of Sec. 56.4911-10(c)) to the extent 
included by a controlling organization (within the meaning of Sec. 
56.4911-10(c)) in its grass roots expenditures.



Sec. 56.4911-7  Affiliated group of organizations.

    (a) Affiliation between two organizations. Sections 4911(f) (1) 
through (3) contain a limited anti-abuse rule for groups of affiliated 
organizations. In general, the rule operates to prevent numerous 
organizations from being created for the purpose of avoiding the 
sliding-scale percentage limitation on an electing public charity's 
lobbying expenditures (as well as avoiding the $1,000,000 cap on a 
single electing public charity's lobbying expenditures). This is 
generally accomplished by treating the members of an affiliated group as 
a single organization for purposes of measuring both lobbying 
expenditures and permitted lobbying expenditures. The anti-abuse rule is 
implemented by this Sec. 56.4911-7 and Sec. Sec. 56.4911-8 and 
56.4911-9. This Sec. 56.4911-7 defines the term ``affiliated group of 
organizations'' and defines the taxable year of an affiliated group of 
organizations. Section 56.4911-8 provides rules concerning the exempt 
purpose expenditures, lobbying expenditures and grass roots expenditures 
of an affiliated group of organizations, as well as rules concerning the 
application of the excise tax imposed by section 4911(a) on

[[Page 543]]

excess lobbying expenditures by the group. Section 56.4911-9 provides 
rules concerning the application of the section 501(h) lobbying 
expenditure limits to members of an affiliated group of organizations. 
(For additional rules for members of a limited affiliated group of 
organizations (generally, organizations that are affiliated solely by 
reason of governing instrument provisions that extend control solely 
with respect to national legislation), see section 4911(f)(4) and Sec. 
56.4911-10).
    (1) In general. For purposes of the regulations under section 4911, 
two organizations are affiliated, subject to the limitation described in 
paragraph (a)(2) of this section, if one organization is able to control 
action on legislative issues by the other by reason of interlocking 
governing boards (see paragraph (b) of this section) or by reason of 
provisions of the governing instruments of the controlled organization 
(see paragraph (c) of this section). The ability of the controlling 
organization to control action on legislative issues by the controlled 
organization is sufficient to establish that the organizations are 
affiliated; it is not necessary that the control be exercised.
    (2) Organizations not described in section 501(c)(3). Two 
organizations, neither of which is described in section 501(c)(3), are 
affiliated only if there exists at least one organization described in 
section 501(c)(3) that is affiliated with both organizations.
    (3) Action on legislative issues. For purposes of this section, the 
term ``action on legislative issues'' includes taking a position in the 
organization's name on legislation, authorizing any person to take a 
position in the organization's name on legislation, or authorizing any 
lobbying expenditures. The phrase does not include actions taken merely 
to correct unauthorized actions taken in the organization's name.
    (b) Interlocking governing boards--(1) In general. Two organizations 
have interlocking governing boards if one organization (the controlling 
organization) has a sufficient number of representatives (within the 
meaning of paragraph (b)(5) of this section) on the governing board of 
the second organization (the controlled organization) so that by 
aggregating their votes, the representatives of the controlling 
organization can cause or prevent action on legislative issues by the 
controlled organization. If two organizations have interlocking 
governing boards, the organizations are affiliated without regard to how 
or whether the representatives of the controlling organization vote on 
any particular matter.
    (2) Majority or quorum. Except as provided in paragraph (b) (3) or 
(4) of this section, the number of representatives of an organization 
(the controlling organization) who are members of the governing board of 
a second organization (the controlled organization) will be presumed 
sufficient to cause or prevent action on legislative issues by the 
controlled organization if that number either--
    (i) Constitutes a majority of incumbents on the governing board, or
    (ii) Constitutes a quorum, or is sufficient to prevent a quorum, for 
acting on legislative issues.
    (3) Votes required under governing instrument or local law. Except 
as provided in paragraph (b)(4) of this section, if under the governing 
documents of an organization (the controlled organization), it can be 
determined that a lesser number of votes than the number described in 
paragraph (b)(2) of this section is necessary or sufficient to cause or 
to prevent action on legislative issues, the number of representatives 
of the controlling organization who are members of the governing board 
of the controlled organization will be considered sufficient to cause or 
prevent action on legislative issues if it equals or exceeds that 
number.
    (4) Representatives constituting less than 15% of governing board. 
Notwithstanding paragraph (b) (2) or (3) of this section, if the number 
of representatives of one organization is less than 15 percent of the 
incumbents on the governing board of a second organization, the two 
organizations are not affiliated by reason of interlocking governing 
boards.
    (5) Representatives. (i) This paragraph (b)(5) describes members of 
the governing board of one organization (the controlled organization) 
who are considered representatives of a second organization (the 
controlling organization). Under this paragraph (b)(5), a

[[Page 544]]

member of the governing board of a controlled organization may be a 
representative of more than one controlling organization. A person with 
no authority to vote on any issue being considered by the governing 
board is not a representative of any organization.
    (ii) A board member of one organization (the controlled 
organization) is a representative of a second organization (the 
controlling organization) if the controlling organization has 
specifically designated that person to be a board member of the 
controlled organization. For purposes of this paragraph (b)(5)(ii) and 
paragraph (b)(5)(iii) of this section, a board member of the controlled 
organization is specifically designated by the controlling organization 
if the board member is selected by virtue of the right of the 
controlling organization, under the governing instruments of the 
controlled organization, either to designate a person to be a member of 
the controlled organization's governing board, or to select a person for 
a position that entitles the holder of that position to be a member of 
the controlled organization's governing board.
    (iii) A board member of one organization who is specifically 
designated by a second organization, a majority of the governing board 
of which is made up of representatives of a third organization, is a 
representative of the third organization as well as being a 
representative of the second organization pursuant to paragraph 
(b)(5)(ii) of this section.
    (iv) A board member of one organization who is also a member of the 
governing board of a second organization is a representative of the 
second organization.
    (v) A board member of one organization who is an officer or paid 
executive staff member of a second organization is a representative of 
the second organization. Although titles are significant in determining 
whether a person is a member of the executive staff of an organization, 
any employee of an organization who possesses authority commonly 
exercised by an executive is considered an executive staff member for 
purposes of this paragraph (b)(5)(v).
    (c) Governing instrument. One organization (the ``controlling'' 
organization) is affiliated with a second organization (the 
``controlled'' organization) by reason of the governing instruments of 
the contolled organization if the governing instruments of the 
controlled organization limit the independent action of the controlled 
organization on legislative issues by requiring it to be bound by 
decisions of the other organization on legislative issues.
    (d) Three or more organizations affiliated--(1) Two controlled 
organizations affiliated. If a controlling organization described in 
this section is affiliated with each of two or more controlled 
organizations described in this section, then the controlled 
organizations are affiliated with each other.
    (2) Chain rule. If one organization is a controlling organization 
described in this section with respect to a second organization and that 
second organization is a controlling organization with respect to a 
third organization, then the first organization is affiliated with the 
third.
    (e) Affiliated group of organizations--(1) Defined. For purposes of 
the regulations under section 4911, an affiliated group of organizations 
is a group of organizations--
    (i) Each of which is affiliated with every other member for at least 
thirty days of the taxable year of the affiliated group (determined 
without regard to the election provided for in paragraph (e)(5) of this 
section),
    (ii) Each of which is an eligible organization (within the meaning 
of Sec. 1.501(h)-2(b)(1)), and
    (iii) At least one of which is an electing member organization 
(within the meaning of paragraph (e)(4) of this section).

Each organization in a group of organizations that satisfies the 
requirements of the preceding sentence is a member of the affiliated 
group of organizations for the taxable year of the affiliated group.
    (2) Multiple membership. For any taxable year of an organization, it 
may be a member of two or more affiliated groups of organizations.
    (3) Taxable year of affiliated group. If all members of an 
affiliated group have the same taxable year, that taxable year is the 
taxable year of the affiliated group. If the members of an affiliated 
group do not all have the same

[[Page 545]]

taxable year, the taxable year of the affiliated group is the calendar 
year, unless the election under paragraph (e)(5) of this section is 
made.
    (4) Electing member organization. For purposes of the regulations 
under section 4911, an ``electing member organization'' is an 
organization to which the expenditure test election under section 501(h) 
applies on at least one day of the taxable year of the affiliated group 
of which it is a member. For purposes of the preceding sentence (and 
notwithstanding Sec. 1.501(h)-2(a)), the expenditure test is not 
considered to apply to the organization on any day before the date on 
which it files the Form 5768 making the expenditure test election.
    (5) Election of member's year as group's taxable year. The taxable 
year of an affiliated group may be determined according to the 
provisions of this paragraph (e)(5) if all of the members of the 
affiliated group so elect. Under this paragraph (e)(5), each member 
organization shall apply the provisions of section 501(h) and 4911, and 
the regulations thereunder (unless the regulations provide otherwise), 
by treating its own taxable year as the taxable year of the affiliated 
group. The election may be made by an electing member organization by 
attaching to its annual return a statement from itself and every other 
member of the affiliated group that contains: the organization's name, 
address, and employer identification number; and its signed consent to 
the election provided for in this paragraph (e)(5). The election must be 
made no later than the due date of the first annual return of any 
electing member for its taxable year for which the member is liable for 
tax under section 4911(a), determined under Sec. 56.4911-8(d). The 
election may not be made or revoked after the due date of the return 
referred to in the preceding sentence except upon such terms and 
conditions as the Commissioner may prescribe.
    (f) Examples. The provisions of this section are illustrated by the 
following examples.

    Example 1. M, N, and O are eligible organizations within the meaning 
of Sec. 1.501(h)-2(b)(1). Each has a governing board made up of nine 
members. Five members on the board of N are also members of the board of 
M. N designates five individuals from among its board, officers, and 
executive staff members to serve on the board of O. M is affiliated with 
N, N is affiliated with O, and M is affiliated with O.
    Example 2. X, an eligible organization, has a board consisting of 10 
members. Five unaffiliated tax-exempt organizations each designate two 
individuals to serve on the governing board of X. A simple majority of 
the board of X is a quorum and may establish X's position on legislative 
issues. X is not affiliated with any of the five autonomous 
organizations by reason of interlocking governing boards.
    Example 3. P and Q are eligible organizations. The governing 
instruments of Q state that it will not take a position on legislation 
if P disapproves of the position. In addition, there is regular 
correspondence between P and Q with regard to positions on legislation. 
P is affiliated with Q regardless of whether P has ever vetoed a 
position taken by Q.
    Example 4. The governing board of organization R resolves to adopt 
the position taken on legislative issues by organization S. R and S are 
eligible organizations and do not have interlocking governing boards. 
The governing instruments of R do not mention organization S and do not 
indicate that R is to be bound by the decisions of legislation of any 
organization. R and S are not affiliated.
    Example 5. Organization Z is bound, under the terms of its governing 
instruments, by the legislative positions of Organization Y. 
Organization Y, however, is bound, under the terms of its governing 
instruments, by the legislative positions of Organization X. 
Organization X is affiliated with Y and Z; Y is affiliated with X and Z; 
and Z is affiliated with X and Y.
    Example 6. Organizations T and U have interlocking boards of 
directors. T is the controlling organization. Organization V is bound, 
under the terms of its governing instruments, by the legislative 
positions of U. T and V are affiliated because T may cause or prevent 
action on legislative issues by U, and V is bound by U's action. If U 
were the controlling organization, T and V would be affiliated as two 
organizations controlled by the same organization.
    Example 7. Organization A is described in section 501(c)(4). It is 
affiliated, as the controlling organization, with organizations K and L, 
both of which are described in section 501(c)(3) and are eligible to 
elect under section 501(h). If K elects under section 501(h), K and L 
are an affiliated group of organizations. Even though A is affiliated 
with K and L, A is not a member of that affiliated group of 
organizations because A is not an eligible organization within the 
meaning of Sec. 1.501(h)-2(b)(1) (see Sec. 56.4911-7(e)(1) for the 
definition of which affiliated organizations may be members of an 
affiliated group of organizations).

[[Page 546]]

    Example 8. G, H, I, and J are eligible organizations. G, H, and I 
have elected the expenditure test under section 501(h). The governing 
board of J has nine members. Under the governing instruments of J, 
organizations G, H, and I each designate three members of the governing 
board of J. Also under the governing instruments of J, action on 
legislative issues requires the approval of any seven board members. 
Because the three representatives of G may prevent action on legislative 
issues, J is affiliated with G. Similarly, J is affiliated with each of 
H and I. However, under none of the rules of affiliation is G affiliated 
with H, or H with I, or I with G. Therefore J is a member of one 
affiliated group comprising G and J, of another group comprising H and 
J, and of a third group comprising I and J.
    Example 9. Organizations C, D, and E have been affiliated for many 
years and have all elected the expenditure test. Each has a taxable year 
ending July 31. For every day of the year ending July 31, 1992, they 
were eligible organizations, electing member organizations, and 
affiliated with each other. On no day of that year were they affiliated 
with any other eligible organization having a different taxable year. 
Therefore, the year ending July 31, 1992, is the taxable year of the 
affiliated group comprising C, D, and E.



Sec. 56.4911-8  Excess lobbying expenditures of affiliated group.

    (a) Application. This section provides rules concerning the exempt 
purpose expenditures, lobbying expenditures, and grass roots 
expenditures of an affiliated group of organizations, and the 
application of the excise tax imposed by section 4911(a) on the excess 
lobbying expenditures of the group.
    (b) Affiliated group treated as one organization. Under section 
4911(f), an affiliated group of organizations is treated as a single 
organization for purposes of the tax imposed by section 4911(a). For any 
taxable year of the affiliated group, the group's lobbying expenditures, 
grass roots expenditures, and exempt purpose expenditures are equal to 
the sum of the lobbying expenditures, grass roots expenditures, and 
exempt purpose expenditures, respectively, paid or incurred by each 
member during the taxable year of the affiliated group. The lobbying and 
grass roots nontaxable amounts for the affiliated group for a taxable 
year are determined under section 4911(c) (2) and (4) and Sec. 56.4911-
1(c) and are based on the sum of the exempt purpose expenditures 
described in the preceding sentence. The lobbying and grass roots 
ceiling amounts for the affiliated group for a taxable year are 
calculated under Sec. 1.501(h)-3(c) (3) and (6) based upon the 
nontaxable amounts determined pursuant to the preceding sentence.
    (c) Tax imposed on excess lobbying expenditures of affiliated group. 
The excise tax under section 4911(a) is imposed for a taxable year of an 
affiliated group if the group has excess lobbying expenditures. For any 
taxable year of an affiliated group, the group's excess lobbying 
expenditures are the greater of--
    (1) The amount by which the group's lobbying expenditures exceed the 
group's lobbying nontaxable amount, or
    (2) The amount by which the group's grass roots expenditures exceed 
the group's grass roots nontaxable amount.
    (d) Liability for tax--(1) Electing organizations. As provided in 
this paragraph (d), an electing member organization is liable for all or 
a portion of the excise tax imposed by section 4911(a) on the excess 
lobbying expenditures of an affiliated group of organizations. An 
organization that is liable under this paragraph (d) is not liable for 
any excise tax under section 4911 based on its own excess lobbying 
expenditures. A member of the affiliated group that is not an electing 
member organization is not liable for any portion of the excise tax that 
is imposed with respect to the affiliated group.
    (2) Tax based on excess lobbying expenditures. If the excise tax 
imposed by section 4911(a) on the excess lobbying expenditures of an 
affiliated group of organizations is based upon the amount described in 
paragraph (c)(1) of this section, and at least one electing member has 
made lobbying expenditures, each electing member organization is liable 
for a portion of the tax equal to the amount of the tax multiplied by a 
fraction, the numerator of which is the electing member organization's 
lobbying expenditures paid or incurred during the taxable year of the 
affiliated group, and the denominator of which is the sum of the 
lobbying expenditures of all electing member organizations in the group 
paid or incurred during the taxable year of the affiliated group.

[[Page 547]]

    (3) Tax based on excess grass roots expenditures. If the excise tax 
imposed by section 4911(a) on the excess lobbying expenditures of an 
affiliated group of organizations is based upon the amount described in 
paragraph (c)(2) of this section, and at least one electing member has 
made grass roots expenditures, each electing member organization is 
liable for a portion of the tax equal to the amount of the tax 
multiplied by the fraction described in paragraph (d)(2) of this 
section, except that ``grass roots expenditures'' is substituted for 
``lobbying expenditures.''
    (4) Tax based on exempt purpose expenditures. If the excise tax 
imposed by section 4911(a) on the excess lobbying expenditures of an 
affiliated group of organizations is based upon the amount described in 
paragraph (c)(2) of this section, and if paragraphs (d)(2) and (d)(3) of 
this section do not apply because no electing organization has made 
lobbying or grass roots expenditures, respectively, each electing member 
organization is liable for a portion of the tax equal to the amount of 
tax multiplied by a fraction the numerator of which is the electing 
member organization's exempt purpose expenditures and the denominator of 
which is the exempt purpose expenditures of all the electing member 
organizations in the affiliated group.
    (5) Taxable year for which liable. An electing member organization 
that is liable for all or a portion of the excise tax imposed by section 
4911(a) on the excess lobbying expenditures of an affiliated group of 
organizations is liable for the tax as if the tax were imposed for its 
taxable year with which or within which ends the taxable year of the 
affiliated group.
    (6) Organization a member of more than one affiliated group. If, 
under this paragraph (d), an organization is liable for its taxable year 
for two or more excise taxes imposed by section 4911(a) on the excess 
lobbying expenditures of two or more affiliated groups, then the 
organization is liable only for the greater of the two or more taxes.
    (e) Former member organization. An electing member organization that 
ceases to be a member of an affiliated group of organizations, the 
taxable year of which is different from its own, must thereafter 
determine its liability under Sec. 56.4911-1 for the excise tax imposed 
by section 4911(a) as if its taxable year were the taxable year of the 
affiliated group of which it was formerly a member. An organization to 
which this paragraph (e) applies that is liable for the excise tax 
imposed by section 4911(a) is liable for the tax as if the tax were 
imposed for its taxable year within which ends the taxable year of the 
affiliated group of which it was formerly a member. The Commissioner 
may, at the Commissioner's discretion, permit an organization to 
disregard the rules of this paragraph (e) and to determine any liability 
under section 4911(a) based upon its own taxable year.



Sec. 56.4911-9  Application of section 501(h) to affiliated groups of
organizations.

    (a) Scope. This section provides rules concerning the application of 
the limitations of section 501(h) to members of an affiliated group of 
organizations (as defined in Sec. 56.4911-7(e)(1)).
    (b) Determination required. For each taxable year of an affiliated 
group of organizations, the calculations described in Sec. 1.501(h)-
3(b)(1) (i) and (ii) must be made, based on the expenditures of the 
group. If, for a taxable year of an affiliated group, it is determined 
that the sum of the affiliated group's lobbying or grass roots 
expenditures for the group's base years exceeds 150 percent of the sum 
of the group's corresponding nontaxable amounts for the base years, then 
under section 501(h), each member organization that is an electing 
member organization (as defined in Sec. 56.4911-7(e)(4)) at any time in 
the taxable year of the affiliated group shall be denied tax exemption 
beginning with its first taxable year beginning after the end of such 
taxable year of the affiliated group. Thereafter, exemption shall be 
denied unless (pursuant to Sec. 1.501(h)-3(d)) the organization 
reapplies and is recognized as exempt as an organization described in 
section 501(c)(3). For purposes of this section, the term base years 
generally means the taxable year of the affiliated group for which a 
determination is made and the group's three preceding taxable years. 
Base years, however, do not include any

[[Page 548]]

year preceding the first year in which at least one member of the group 
was treated as described in section 501(c)(3).
    (c) Member organizations that are not electing organizations. An 
organization that is a member of an affiliated group of organizations 
but that is not an electing member organization remains subject to the 
``substantial part test'' described in section 501(c)(3) with respect to 
its activities involving attempts to influence legislation.
    (d) Filing of information relating to affiliated group of 
organizations--(1) Scope. The filing requirements described in this 
paragraph (d) apply to each member of an affiliated group or 
organizations for the taxable year of the member with which, or within 
which, ends the taxable year of the affiliated group.
    (2) In general. Each member of an affiliated group of organizations 
shall provide to every other member of the group, before the first day 
of the second month following the close of the affiliated group's 
taxable year, its name, identification number, and the information 
required under Sec. 1.6033-2(a)(2)(ii)(k) for its expenditures during 
the group's taxable year and for prior taxable years of the group that 
are base years under paragraph (b). For groups electing under Sec. 
56.4911-7(e)(5) to have each member file information with respect to the 
group based on its taxable year, each member shall provide the 
information required by the preceding sentence by treating each taxable 
year of any member of the group as a taxable year for the group.
    (3) Additional information required. In addition to the information 
required by Sec. 1.6033-2(a)(2)(ii)(k), each member of an affiliated 
group of organizations must provide on its annual return the group's 
taxable year and, if the election under Sec. 56.4911-7(e)(5) is made, 
the name, identification number, and taxable year identifying the return 
with which its consent to the election was filed.
    (4) Information required of electing member organization. In 
addition to the information required by Sec. 1.6033-2(a)(2)(ii)(k) and 
paragraph (d)(3) of this section, each electing member organization (as 
defined in Sec. 56.4911-7(e)(4)) must provide on its annual return--
    (i) The name and identification number of each member of the group, 
and
    (ii) The appropriate calculation described in Sec. 56.4911-8(d), if 
the organization is an electing member organization liable for all or 
any portion of the excise tax imposed by section 4911(a).
    (e) Example. The provisions of this section may be illustrated by 
the following example:

    Example. (1) M, N, and O are affiliated organizations under Sec. 
56.4911-7(a). M's taxable year ends November 30, N's, January 31, and 
O's, June 30. On June 20, 1979, O files Form 5768 to elect to be 
governed by the expenditure test. M files Form 5768 in December of 1979. 
Neither M nor O revokes the election, and no organization makes the 
election provided for in Sec. 56.4911-7(e)(5). M, N, and O constitute 
an affiliated group of organizations, the first taxable year of which is 
the calendar year 1979.
    (2) Because the organizations did not elect under Sec. 56.4911-
7(e)(5) to use their own taxable years as the group's taxable years, the 
expenditures of the affiliated group for its first taxable year are the 
expenditures made by M, N, and O during calendar year 1979, and are 
reported by M, N, and O on their returns for their taxable years within 
which falls December 31, 1979. M reports the expenditures of the 
affiliated group for 1979 on its return for its taxable year ending 
November 30, 1980; and O, on its return for its taxable year ending June 
30, 1980. N is not an electing member (as defined in Sec. 56.4911-
7(e)(4)). Accordingly, under paragraph (d)(3)(i) of this section, it 
reports the name and identification number of each member of the group.
    (3) The following tables summarize the expenditures by the 
affiliated group for the calendar years indicated. None of the group's 
lobbying expenditures for its taxable years 1979 through 1982 were grass 
roots expenditures.

                                          Table I--Group's Expenditures
----------------------------------------------------------------------------------------------------------------
                                   Exempt purpose                                    Lobbying        Lobbying
               Year                 expenditures            Calculation             nontaxable     expenditures
                                        (EPE)                                      amount (LNTA)       (LE)
----------------------------------------------------------------------------------------------------------------
1979.............................        $400,000  (20%x$400,000=)..............         $80,000        $100,000
1980.............................         300,000  (20%x$300,000=)..............          60,000         100,000

[[Page 549]]

 
1981.............................         600,000  (20%x$500,000+...............         115,000         120,000
                                                   15%x$100,000=)...............
1982.............................         500,000  (20%x$500,000=)..............         100,000         220,000
                                  ----------------                               -------------------------------
      Total......................       1,800,000  .............................         355,000         540,000
----------------------------------------------------------------------------------------------------------------


                                        Table II--Expenditures of M and O
----------------------------------------------------------------------------------------------------------------
                                        Exempt purpose      Lobbying nontaxable        Lobbying
                                         expenditures             amount             expenditures
                                    ------------------------------------------------------------------  M plus O
                                         M          O          M          O          M          O
----------------------------------------------------------------------------------------------------------------
1979...............................    125,000    100,000     25,000     20,000     60,000     20,000     80,000
1980...............................    100,000     50,000     20,000     10,000     40,000     40,000     80,000
1981...............................    250,000    100,000     50,000     20,000     60,000     40,000    100,000
1982...............................    200,000    100,000     40,000     20,000    160,000     40,000    200,000
----------------------------------------------------------------------------------------------------------------

    (4) For the affiliated group's taxable years 1979, 1980, 1981, and 
1982, the group has excess lobbying expenditures. Under section 
4911(f)(1)(B) and Sec. 56.4911-8(d), M and O, as electing member 
organizations, are liable for a portion of the 25 percent excise tax 
imposed on the group's excess lobbying expenditures, based on their 
respective shares of the lobbying expenditures of all electing member 
organizations. For 1979, the excess lobbying expenditures are $20,000 
($100,000-$80,000). The tax is 25% of $20,000 or $5,000; M must pay 
$3,750 (($60,000/$80,000) x $5,000 = $3,750), and O must pay $1,250 
(($20,000/$80,000) x $5,000 = $1,250). For 1980, the tax is $10,000 and 
each must pay $5,000. For 1981, the tax is $1,250, of which M must pay 
$750 and O must pay $500. For 1982, the tax is $30,000. M must pay 
$24,000 and O must pay $6,000. M and O are not liable for any separate 
4911 excise tax that otherwise would have been imposed on their separate 
excess lobbying expenditures.
    (5) Under Sec. 56.4911-9(b), the group must make the calculation 
described in Sec. 1.501(h)-3(b)(1) for each of the group's taxable 
years 1979 through 1982. The following illustrates only the required 
calculation for the group's taxable year 1982. For its taxable year 
1982, the group must determine whether it normally has made lobbying 
expenditures in excess of its lobbying ceiling amount. The determination 
takes into account the group's expenditures in base years 1979 through 
1982. The sum of the group's lobbying expenditures for the base years 
($540,000) exceeds 150% of the sum of the group's lobbying nontaxable 
amounts for the base years (150% x $355,000 = $532,500). Therefore, for 
its taxable year 1982, the group normally has made lobbying expenditures 
in excess of its lobbying ceiling amount. Under section 501(h) and Sec. 
56.4911-9(b), M is not exempt from tax under section 501(a) as an 
organization described in section 501(c)(3) for its taxable year 
beginning December 1, 1983, and O is not exempt for its year beginning 
July 1, 1983. Whether N's lobbying expenditures disqualify it for tax 
exemption at any time after January 1, 1979, is determined under the 
substantial part test of section 501(c)(3).

    (f) Cross reference. For other provisions relating to members of an 
affiliated group or organizations, see Sec. Sec. 56.4911-2(c)(4)(ii), 
56.4911-4(c)(2), 56.4911-4(e), and 56.4911-5(f)(3).



Sec. 56.4911-10  Members of a limited affiliated group of organizations.

    (a) Scope. This section provides additional rules for members of a 
limited affiliated group of organizations, as defined in paragraph (b) 
of this section (relating generally to organizations that are affiliated 
solely by reason of provisions of their governing instruments that 
extend control solely with respect to national legislation). Except as 
otherwise provided in this section, Sec. Sec. 56.4911-8 and 56.4911-9 
do not apply to members of a limited affiliated group. Thus, as modified 
by this section, the regulations under sections 501(h) and 4911 apply to 
electing members of a limited affiliated group individually. For 
example, Sec. Sec. 56.4911-2 through 56.4911-4, which, by their terms, 
include amounts described in paragraph (d) of this section, are used in 
applying sections 501(h) and 4911 to controlling member organizations 
(within the

[[Page 550]]

meaning of paragraph (c) of this section). Except as otherwise provided 
in this section, members of a limited affiliated group that are not 
electing organizations are subject to the substantial part test.
    (b) Members of limited affiliated group. For purposes of section 
4911, a limited affiliated group consists of two or more organizations 
that meet the following requirements:
    (1) Each organization is a member of an affiliated group of 
organizations as defined in Sec. 56.4911-7(e);
    (2) No two members of the affiliated group described in paragraph 
(b)(1) of this section are affiliated by reason of interlocking 
governing boards under Sec. 56.4911-7(b); and
    (3) No member of the affiliated group described in paragraph (b)(1) 
of this section is, under its governing instrument, bound by decisions 
of one or more of the other such members on legislative issues other 
than national legislative issues.

Each organization in a group of organizations that satisfies the 
requirements of the preceding sentence is a member of the limited 
affiliated group.
    (c) Controlling and controlled organizations. For purposes of this 
section, a member of a limited affiliated group is a controlling member 
organization if it controls one or more of the other members of the 
limited affiliated group, and a member of a limited affiliated group is 
a controlled member organization if it is controlled by one or more of 
the other members of the limited affiliated group. For purposes of the 
preceding sentence, whether an organization controls a second 
organization shall be determined by whether the second organization is 
bound, under its governing instruments, by actions taken by the first 
organization on national legislative issues.
    (d) Expenditures of controlling organization--(1) Scope. This 
paragraph (d) applies to a controlling member organization that has the 
expenditure test election in effect for its taxable year. This paragraph 
(d) applies whether or not the organization is also a controlled member 
organization. In determining a controlling member organization's 
expenditures, no expenditure shall be counted twice.
    (2) Expenditures for direct lobbying. A controlling member 
organization for which the expenditure test election is in effect shall 
include in its direct lobbying expenditures for its taxable year the 
direct lobbying expenditures (as defined in Sec. Sec. 56.4911-2 and 
56.4911-3) paid or incurred with respect to national legislative issues 
during such year by each organization that is a member of the limited 
affiliated group and is controlled (within the meaning of paragraph (c) 
of this section) by such controlling member organization.
    (3) Grass roots expenditures. A controlling member organization for 
which the expenditure test election is in effect shall include in its 
grass roots expenditures for its taxable year the grass roots 
expenditures (as defined in Sec. Sec. 56.4911-2 and 56.4911-3) paid or 
incurred with respect to national legislative issues during such year by 
each organization that is a member of the limited affiliated group and 
is controlled (within the meaning of paragraph (c) of this section) by 
such controlling member organization.
    (4) Exempt purpose expenditures. The exempt purpose expenditures of 
a controlling member organization do not include the exempt purpose 
expenditures (other than lobbying expenditures described in paragraphs 
(d)(2) and (d)(3) of this section) of any organization that is a 
controlled member organization with respect to it.
    (e) Expenditures of controlled member. A controlled member 
organization that is an electing organization but that does not control 
(within the meaning of paragraph (c) of this section) any organization 
in the limited affiliated group shall apply sections 501(h) and 4911 and 
the regulations thereunder without regard to the expenditures of any 
other member of the limited affiliated group.
    (f) Reports of members of limited affiliated groups--(1) Controlling 
member organization's additional information on annual return. In 
addition to the information required by Sec. 1.6033-2(a)(2)(ii)(k), 
each controlling member organization for which the expenditure test 
election is in effect must provide on its annual return the name and 
identification number of each member of the limited affiliated group.

[[Page 551]]

    (2) Reports of controlling members to other members. Each 
controlling member organization for which an expenditure test election 
is in effect must notify each member that it controls of its taxable 
year in order for the controlled organization to prepare the report 
required by paragraph (f)(3) of this section. Such notification must be 
made before the beginning of the second month after the close of each 
taxable year of the controlling member for which the election is in 
effect.
    (3) Reports of controlled member organization. Every controlled 
member organization (whether or not the expenditure test election is in 
effect with respect to it) shall provide to each member of the limited 
affiliated group that controls it, before the first day of the second 
month following the close of the taxable year of each such controlling 
organization, its name, identification number, and the lobbying 
expenditures and grass roots expenditures on national legislative issues 
incurred by the controlled member organization.
    (g) National legislative issues. The term ``national legislative 
issue'' means legislation, limited to action by the Congress of the 
United States or by the public in any national procedure. If an issue is 
both national and local, it is characterized as a national legislative 
issue if the contemplated legislation is Congressional legislation.
    (h) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. State X has an income tax law that uses definitions 
contained in the Internal Revenue Code as it may be amended from time to 
time. Legislation to change a definition in the Internal Revenue Code is 
pending in Congress. This is a national legislative issue even though 
Congressional action may affect state law.
    Example 2. Organization M takes a position favoring approval by 
Congress of a proposed amendment to the United States Constitution. This 
is a national legislative issue. After approval by Congress and 
submission to the states for ratification, the proposed amendment ceases 
to be a national legislative issue.
    Example 3. N, O, and P are organizations described in section 
501(c)(3) that do not have interlocking governing boards, within the 
meaning of Sec. 56.4911-7(b). N has elected the expenditure test under 
section 501(h). By virtue of the governing instruments of O and P, any 
decision made by N on national legislative issues (such as issues 
concerning action on acts, bills, resolutions, or similar items by 
Congress) binds both O and P. Under their governing instruments, O and P 
are not bound on any other issues. Therefore, N, O, and P constitute a 
limited affiliated group. If P sends a series of letters and pamphlets 
to members of Congress in support of bill V, their cost will be included 
in N's and P's expenditures for direct lobbying and in N's and P's 
exempt purposes expenditures, but will not be included in O's lobbying 
expenditures. If N hires a lobbyist to solicit support for bill V, the 
cost of hiring the lobbyist will be includable only in N's lobbying 
expenditures. Any lobbying expenditures incurred by either O or P on any 
issue that is not a national legislative issue will not be included in 
N's lobbying expenditures.
    Example 4. Y is an electing organization and a member of a limited 
affiliated group of organizations. Y controls organizations A, B, and C 
with respect to national legislative issues but is not controlled by any 
other organization.--Y's taxable year is the calendar year. During 1982, 
A dissolves on March 15th and D, also controlled by Y with respect to 
national legislative issues, is established on May 1st. For 1982 the 
limited affiliated group comprises Y, A, B, C, and D.
    Example 5. P, Q, R, and S are electing organizations. The governing 
instruments of Q require it to adopt the positions on national 
legislative issues adopted by P. R is similarly bound by Q's positions. 
R and S have interlocking governing boards, within the meaning of Sec. 
56.4911-7(b), but S's governing instruments do not require it to adopt 
the position of any other organization on any legislative issues. Under 
Sec. 56.4911-7(e)(1), P, Q, R, and S are members of an affiliated 
group. Applying paragraph (b) of this section, it is determined that (1) 
P, Q, R and S are members of an affiliated group; and (2) R and S are 
affiliated by reason of interlocking governing boards. Accordingly, P, 
Q, R and S are not a limited affiliated group. Similarly, P, Q, and R do 
not constitute a limited affiliated group because they are members of an 
affiliated group comprising P, Q, R, and S, two of whose members, R and 
S, are affiliated by reason of interlocking governing boards.
    Example 6. T, U, V, and W are electing organizations. The governing 
instruments of U and V require them to adopt the positions on national 
legislative issues adopted by T, but do not require them to adopt the 
positions of any organization on any other legislative issues. The 
governing documents of W require it to adopt the positions of V on all 
legislative issues. Applying paragraph (b) of this section, it is 
determined that (1) T, U, V, and W are all members of an affiliated 
group; (2) no two of T, U, V, and W are affiliated by reason of 
interlocking governing boards; but

[[Page 552]]

(3) W is bound, under its governing instrument, by decisions of V on 
legislative issues that are not national legislative issues. 
Accordingly, T, U, V, and W do not constitute a limited affiliated 
group. Similarly, T, U, and V do not constitute a limited affiliated 
group. T, U, V, and W are an affiliated group under Sec. 56.4911-7.



Sec. 56.6001-1  Notice or regulations requiring records, statements,
and special returns.

    (a) In general. The provisions of Sec. 53.6001-1 shall apply to any 
person subject to tax under chapter 41, subtitle D, of the Code, by 
treating each reference to chapter 42 in Sec. 53.6001-1 as a reference 
to chapter 41.
    (b) Cross references. See Sec. 56.4911-6 for general information on 
records of lobbying expenditures. See Sec. Sec. 56.4911-9(d) and 
56.4911-10(f) for information that members of an affiliated group and a 
limited affiliated group, respectively, are to provide to other members 
of the group and to the Internal Revenue Service.



Sec. 56.6011-1  General requirement of return, statement, or list.

    Every organization liable for the tax imposed by section 4911(a) 
shall file an annual return with respect to the tax on the form 
prescribed by the Internal Revenue Service for that purpose and shall 
include the information required by the form and its instructions.



Sec. 56.6011-4  Requirement of statement disclosing participation in
certain transactions by taxpayers.

    (a) In general. If a transaction is identified as a listed 
transaction or a transaction of interest as defined in Sec. 1.6011-4 of 
this chapter by the Commissioner in published guidance (see Sec. 
601.601(d)(2) of this chapter), and the listed transaction or 
transaction of interest involves an excise tax under chapter 41 of 
subtitle D of the Internal Revenue Code (relating to public charities), 
the transaction must be disclosed in the manner stated in such published 
guidance.
    (b) Effective date. This section applies to listed transactions 
entered into on or after January 1, 2003. This section applies to 
transactions of interest entered into on or after November 2, 2006.

[T.D. 9350, 72 FR 43154, Aug. 3, 2007]



Sec. 56.6060-1  Reporting requirements for tax return preparers.

    (a) In general. A person that employs one or more tax return 
preparers to prepare a return or claim for refund of tax under chapter 
41 of subtitle D of the Internal Revenue Code, other than for the 
person, at any time during a return period, shall satisfy the record 
keeping and inspection requirements in the manner stated in Sec. 
1.6060-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78460, Dec. 22, 2008]



Sec. 56.6107-1  Tax return preparer must furnish copy of return and 
claim for refund to taxpayer and must retain a copy or record.

    (a) In general. A person who is a signing tax return preparer of any 
return or claim for refund of tax under Chapter 41 of subtitle D of the 
Internal Revenue Code shall furnish a completed copy of the return or 
claim for refund to the public charity and retain a completed copy or 
record in the manner stated in Sec. 1.6107-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78460, Dec. 22, 2008]



Sec. 56.6109-1  Tax return preparers furnishing identifying numbers 
for returns or claims for refund.

    (a) In general. Each tax return or claim for refund for tax under 
chapter 41 of subtitle D prepared by one or more signing tax return 
preparers must include the identifying number of the preparer required 
by Sec. 1.6695-1(b) of this chapter to sign the return or claim for 
refund in the manner stated in Sec. 1.6109-2 of this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed after December 31, 
2008.

[T.D. 9436, 73 FR 78460, Dec. 22, 2008]

[[Page 553]]



Sec. 56.6694-1  Section 6694 penalties applicable to tax return 
preparer.

    (a) In general. For general definitions regarding section 6694 
penalties applicable to preparers of tax returns or claims for refund of 
tax under chapter 41 of subtitle D see Sec. 1.6694-1 of this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed, and advice provided, 
after December 31, 2008.

[T.D. 9436, 73 FR 78460, Dec. 22, 2008]



Sec. 56.6694-2  Penalties for understatement due to an unreasonable 
position.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of excise tax under chapter 41 of subtitle D of the 
Internal Revenue Code (Code) shall be subject to penalties under section 
6694(a) of the Code in the manner stated in Sec. 1.6694-2 of this 
chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78460, Dec. 22, 2008]



Sec. 56.6694-3  Penalty for understatement due to willful, reckless,
or intentional conduct.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under chapter 41 of subtitle D of the 
Internal Revenue Code (Code) shall be subject to penalties under section 
6694(b) of the Code in the manner stated in Sec. 1.6694-3 of this 
chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78460, Dec. 22, 2008]



Sec. 56.6694-4  Extension of period of collection when tax return
preparer pays 15 percent of a penalty for understatement of taxpayer's

liability and certain other procedural matters.

    (a) In general. For rules relating to the extension of period of 
collection when a tax return preparer who prepared a return or claim for 
refund for tax under chapter 41 of subtitle D of the Internal Revenue 
Code pays 15 percent of a penalty for understatement of taxpayer's 
liability and procedural matters relating to the investigation, 
assessment and collection of the penalties under section 6694(a) and 
(b), the rules under Sec. 1.6694-4 of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]



Sec. 56.6695-1  Other assessable penalties with respect to the 
preparation of tax returns or claims for refund for other persons.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under chapter 41 of subtitle D of the 
Internal Revenue Code (Code) shall be subject to penalties for failure 
to furnish a copy to the taxpayer under section 6695(a) of the Code, 
failure to sign the return under section 6695(b) of the Code, failure to 
furnish an identification number under section 6695(c) of the Code, 
failure to retain a copy or list under section 6695(d) of the Code, 
failure to file a correct information return under section 6695(e) of 
the Code, and negotiation of a check under section 6695(f) of the Code, 
in the manner stated in Sec. 1.6695-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]



Sec. 56.6696-1  Claims for credit or refund by tax return preparers.

    (a) In general. For rules relating to claims for credit or refund by 
a tax return preparer who prepared a return or claim for refund for tax 
under chapter 41 of subtitle D of the Internal Revenue Code, the rules 
under Sec. 1.6696-1 of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]

[[Page 554]]



Sec. 56.7701-1  Tax return preparer.

    (a) In general. For the definition of a tax return preparer, see 
Sec. 301.7701-15 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]



PART 141_TEMPORARY EXCISE TAX REGULATIONS UNDER THE EMPLOYEE RETIREMENT
INCOME SECURITY ACT OF 1974--Table of Contents





Sec. 141.4975-13  Definition of ``amount involved'' and ``correction''.

    Until superseded by permanent regulations under sections 4975(f) (4) 
and (5), Sec. 53.4941(e)-1 of this chapter (Foundation Excise Tax 
Regulations) will be controlling to the extent such regulations describe 
terms appearing both in section 4941(e) and section 4975(f). Because of 
the need for immediate guidance with respect to the provisions contained 
in this Treasury decision, it is found impracticable to issue it with 
notice and public procedure thereon under subsection (b) of section 553 
of Title 5 of the United States Code or subject to the effective date 
limitation of subsection (d) of that section.

(Sec. 7805 of the Internal Revenue Code of 1954 (68A Stat. 917; 26 
U.S.C. 7805))

[T.D. 7425, 41 FR 32890, Aug. 6, 1976, as amended by T.D. 8084, 51 FR 
16305, May 2, 1986]



PART 143_TEMPORARY EXCISE TAX REGULATIONS UNDER THE TAX REFORM ACT OF
1969--Table of Contents



Sec.
143.1 [Reserved]
143.2 Taxes on self-dealing; scholarship and fellowship grants by 
          private foundations.
143.3-143.4 [Reserved]
143.5 Taxes on self-dealing; indirect transactions by a private 
          foundation.
143.6 Election to shorten the period during which certain excess 
          business holdings of private foundations are treated as 
          permitted holdings.

    Authority: Sec. 7805, 68A Stat. 917; 26 U.S.C. 7805.



Sec. 143.1  [Reserved]



Sec. 143.2  Taxes on self-dealing; scholarship and fellowship grants 
by private foundations.

    (a) In general. Section 4941(d)(1)(D) of the Internal Revenue Code 
of 1954 as added by section 101(b) of the Tax Reform Act of 1969 (83 
Stat. 500) provides that the term ``self-dealing'' includes any direct 
or indirect payment of compensation (or payment or reimbursement of 
expenses) by a private foundation to a disqualified person. Section 
4941(d)(1)(E) provides that the term ``self-dealing'' includes any 
direct or indirect transfer to, or use by, or for the benefit of, a 
disqualified person of the income or assets of a private foundation.
    (b) Scholarship and fellowship grants. A scholarship or fellowship 
grant to a person other than a Government official paid or incurred by a 
private foundation in accordance with a program which is consistent with 
the allowance of a deduction under section 170 for contributions made to 
such private foundation shall not constitute an act of self-dealing. For 
example, a scholarship or fellowship grant made by a private foundation 
in accordance with a program to award scholarship or fellowship grants 
to the children of employees of the donor shall not constitute an act of 
self-dealing if the private foundation has, after disclosure of the 
method of carrying out such program, received a ruling or determination 
letter stating that it is exempt from taxation under section 501(c)(3) 
and that contributions to the private foundation are deductible by the 
donor under section 170.

[T.D. 7030, 35 FR 4293, Mar. 10, 1970]



Sec. Sec. 143.3-143.4  [Reserved]



Sec. 143.5  Taxes on self-dealing; indirect transactions by a private 
foundation.

    (a) In general. Section 4941(d)(1)(D) of the Internal Revenue Code 
of 1954 as added by section 101(b) of the Tax Reform Act of 1969 (83 
Stat. 500) provides that the term ``self-dealing'' includes

[[Page 555]]

any direct or indirect payment of compensation (or payment or 
reimbursement of expenses) by a private foundation to a disqualified 
person. Section 4941(d)(1)(E) provides that the term ``self-dealing'' 
includes any direct or indirect transfer to, or use by, or for the 
benefit of, a disqualified person of the income or assets of a private 
foundation. Section 4941(d)(1)(F) provides that the term ``self-
dealing'' includes any direct or indirect agreement by a private 
foundation to make any payment of money or other property to a 
government official other than an agreement to employ such individual 
for any period after the termination of his government service if such 
individual is terminating his government service within a 90-day period.
    (b) Indirect transactions by a private foundation. A transaction 
engaged in directly with a Government official by an organization 
described in section 509(a) (1), (2), or (3) which is the recipient of a 
grant from a private foundation shall not constitute an indirect act of 
self-dealing between such private foundation and Government official if 
the private foundation does not earmark the use of the grant for any 
named Government official and does not control or retain any veto power 
over the selection of the Government official by the grantee 
organization. For purposes of the preceding sentence, a grant by a 
private foundation shall not constitute an indirect act of self-dealing 
even though such foundation had reason to believe that certain 
Government officials would derive benefits from such grant so long as 
the grantee, in fact, exercises control over the selecting process and 
actually makes the selection completely independent of the private 
foundation.
    (c) Example. The provisions of subsection (b) of this section may be 
illustrated by the following example.

    Example. A private foundation made a grant to an organization 
described in section 509(a) (1), (2), or (3) to conduct a judicial 
seminar. The grantee conducting the seminar made payments to certain 
Government officials. By the nature of the seminar the grantor 
foundation had reason to believe that Government officials would be 
compensated for participation in such seminar. The grantee, however, had 
complete independent control over the selection of such participants. 
Since the grantee has not acted as a conduit for the private foundation 
and has, in fact, exercised independent control over the use of the 
grant, such grant by the private foundation shall not constitute an act 
of self-dealing with respect to the Government officials.

[T.D. 7036, 35 FR 6322, Apr. 18, 1970]



Sec. 143.6  Election to shorten the period during which certain excess
business holdings of private foundations are treated as permitted

holdings.

    (a) In general. Under section 4943(c)(4)(B)(ii), where the combined 
holdings on May 26, 1969, of a private foundation and all disqualified 
persons in any one business enterprise exceed 75 percent of the voting 
stock or more than a 75 percent interest in the value of all outstanding 
shares of all classes of stock in such enterprise, and the foundation's 
holdings on such date do not exceed 95 percent of the voting stock in 
such enterprise, then such combined holdings must be reduced to 50 
percent of the voting stock of such enterprise by the end of a 15-year 
period beginning on May 26, 1969. However, under section 4943(c)(4)(E), 
the 15-year period during which such combined holdings in the enterprise 
must be reduced to 50 percent is to be shortened to a 10-year period, 
referred to in section 4943(c)(4)(B)(iii), if, at any time before 
January 1, 1971, one or more individuals:
    (1) Who are substantial contributors (as described in section 
507(d)(2)) or members of the family within the meaning of section 
4946(d) of one or more substantial contributors to such private 
foundation, and
    (2) Who on May 26, 1969, held in aggregate more than 15 percent of 
the voting stock of the enterprise, make an election in the manner 
described in paragraph (b). If an individual who owns 15 percent or less 
of the voting stock of the enterprise wishes to make an election under 
this paragraph, he and one or more other individuals who together own 
more than 15 percent of the voting stock of the enterprise may join in 
making an election by together filing the statement referred to in 
paragraph (b) of this section.
    (b) Manner of making election. The election referred to in paragraph 
(a) of

[[Page 556]]

this section is made by filing two copies of a written statement with 
the Office of the Assistant Commissioner (Technical), Internal Revenue 
Service, Washington, DC 20224.
    (c) Additional copies. The individual filing the written statement 
referred to in paragraph (b) of this section shall submit a copy of the 
statement to the private foundation with respect to which the election 
is being made and to the management of such business enterprise.
    (d) Content of statement. The statement shall indicate that an 
election is being made under section 4943(c) (4)(E) of the Code, and 
shall be signed by each of the individuals making the election, and, in 
addition shall contain the following information:
    (1) The name, address, and taxpayer identification number of each of 
the individuals making the election;
    (2) The name and address of the foundation with respect to which 
such election is being made;
    (3) The name and address of the business enterprise with respect to 
which the election is being made;
    (4) The aggregate number of shares of voting stock in the business 
enterprise that were held on May 26, 1969, by each individual making the 
election, and, in addition, the percentage that such voting stock is of 
the total number of shares of voting stock issued and outstanding on 
such date;
    (5) The aggregate number of shares of voting stock in the business 
enterprise held by the private foundation on May 26, 1969, and, in 
addition, the percentage that such voting stock is of the total number 
of shares of voting stock issued and outstanding on such date; and
    (6) The total number of shares of voting stock in the business 
enterprise or the best available estimate thereof, that were issued and 
outstanding on May 26, 1969.
    (e) Time for making election. The statement referred to in paragraph 
(b) of this section shall be filed before January 1, 1971.

[T.D. 7038, 35 FR 6962, May 1, 1970]



PART 145_TEMPORARY EXCISE TAX REGULATIONS UNDER THE HIGHWAY REVENUE ACT
OF 1982 (PUB. L. 97 424)--Table of Contents



Sec.
145.4051-1 Imposition of tax on heavy trucks and trailers sold at 
          retail.
145.4052-1 Special rules and definitions.
145.4061-1 Application to manufacturers tax.

    Authority: 26 U.S.C. 7805.
    Sections 145.4051-1 and 145.4052-1 also issued under 26 U.S.C. 4051 
and 4052.

    Source: T.D. 7882, 48 FR 14362, Apr. 4, 1983, unless otherwise 
noted.



Sec. 145.4051-1  Imposition of tax on heavy trucks and trailers sold at
retail.

    (a) Imposition of tax--(1) In general. Section 4051(a)(1) imposes a 
tax on the first retail sale (as defined in Sec. 145.4052-1(a)) of the 
following articles (including in each case parts or accessories therefor 
sold on or in connection therewith or with the sale thereof):
    (i) Automobile truck chassis and bodies;
    (ii) Truck trailer and semitrailer chassis and bodies; and
    (iii) Tractors of the kind chiefly used for highway transportation 
in combination with a trailer or semitrailer.

A sale of an automobile truck, truck trailer or semitrailer, shall be 
considered to be a sale of a chassis and of a body enumerated in this 
paragraph (a)(1).
    (2) Special rule applicable to chassis and bodies. A chassis or body 
enumerated in paragraph (a)(1) of this section is taxable under section 
4051(a)(1) only if such chassis or body is sold for use as a component 
part of a highway vehicle (as defined in paragraph (d) of Sec. 
48.4061(a)-1 (Regulations on Manufacturers and Retailers Excise Taxes)), 
which is an automobile truck, truck trailer or semitrailer, or a tractor 
of the kind chiefly used for highway transportation in combination with 
a trailer or semitrailer. Furthermore, a chassis or body which is not 
enumerated in paragraph (a)(1) of this section is not taxable under 
section 4051(a)(1) even though such chassis or body is used as a 
component part of a highway vehicle (e.g., a chassis or body of a 
passenger automobile). See paragraphs

[[Page 557]]

(e)(1) and (e)(2) of this section for the definitions of a tractor and 
truck. See paragraphs (e) (1) through (5) of Sec. 145.4052-1 for other 
provisions applicable to this section. See paragraph (f) of this 
section, relating to tax-free sales of non-highway vehicles.
    (3) Parts or accessories sold on or in connection with chassis, 
bodies, etc. The tax applies in respect of parts or accessories sold on 
or in connection with or with the sale of the vehicles specified in 
section 4051(a)(1). Thus, for example, if at the time the article is 
sold by the retailer, the part or accessory has been ordered from the 
retailer, the part or accessory will be considered as sold in connection 
with and with the sale of the vehicle. The tax applies in such a case 
whether or not the parts or accessories are billed separately by the 
retailer. If a taxable chassis, body, or tractor is sold by the 
retailer, without parts or accessories which are considered equipment 
essential for the operation or appearance of the taxable article, the 
sale of such parts or accessories by the retailer to the purchaser of 
the taxable article will be considered, in the absence of evidence to 
the contrary, to have been made in connection with the sale of the 
taxable article even though they are shipped separately, at the same 
time or on a different date. For example, if a retailer sells to any 
person a chassis and the bumpers for such chassis, or sells a taxable 
tractor and the fifth wheel and attachments, the tax applies to such 
parts or accessories regardless of the method of billing or the time at 
which the shipments were made. Parts and accessories that are spares or 
replacements are not subject to tax.
    (4) Exclusions. No tax is imposed by section 4051(a)(1) on the sale 
of automobile truck chassis and bodies, suitable for use with a vehicle 
which has a gross vehicle weight of 33,000 pounds or less, or truck 
trailer and semitrailer chassis and bodies, suitable for use with a 
trailer or semitrailer which has a gross vehicle weight of 26,000 pounds 
or less. For purposes of this paragraph (a)(4) the term suitable for use 
means practical and commercial fitness for such use. A chassis or body 
possesses practical fitness for use with a vehicle if it performs its 
intended function up to a generally acceptable standard of efficiency 
with the vehicle, and a chassis or body possesses commercial fitness for 
use with a vehicle if it is generally available for use with the vehicle 
at a price that is reasonably competitive with other articles that may 
be used for the same purpose. Thus, a truck chassis which is suitable 
for use with a vehicle having a gross vehicle weight of 33,000 pounds or 
less, is not subject to the tax imposed by section 4051(a)(1) regardless 
of the body actually mounted thereon. A truck trailer or semitrailer 
chassis suitable for use with a vehicle having a gross vehicle weight of 
26,000 pounds or less, is not subject to tax regardless of the body 
actually mounted thereon. Where an exempt body is mounted on a taxable 
chassis, or a taxable body is mounted on an exempt chassis, the taxable 
chassis or body, as the case may be, nevertheless remains subject to 
such tax, if the resulting vehicle is a highway vehicle as defined in 
Sec. 48.4061(a)-1.
    (b) Rate of tax. With respect to the articles enumerated in 
paragraph (a)(1) of this section, the rate of tax imposed by section 
4051(a)(1) is 12 percent of the price for which the article is sold on 
or after April 1, 1983. See paragraph (d) of this section relating to 
vehicles on which a 10 percent tax was imposed under section 4061(a)(1).
    (c) Separate purchase of truck or trailer and parts and accessories 
therefor--(1) In general. If the owner, lessee, or operator of any 
vehicle, which contains an article taxable under paragraph (a)(1) of 
this section, installs (or causes to be installed) any part or accessory 
on such vehicle, and such installation is not later than 6 months after 
the date such vehicle (as it contains such article) was first placed in 
service, section 4051(b)(1) imposes a tax on such installation equal to 
12 percent of the price of such part or accessory and its installation. 
For purposes of the tax imposed by section 4051(b)(1) and this paragraph 
(c)(1) the term ``parts and accessories'' does not include those parts 
and accessories which were previously exempt from tax under sections 
4061(b) (1) and (2) as in effect prior to January 7, 1983. Thus, for 
example, articles of general use are exempt from tax. See Sec. 
48.4061(b)-2 (b). See paragraphs (d) (1)

[[Page 558]]

through (4) of Sec. 145.4052-1 for determination of price.
    (2) Placed in service. For purposes of paragraph (c)(1) of this 
section, a vehicle shall be considered placed in service on the date on 
which the owner of the vehicle took actual possession of the vehicle. 
This date can be established by the delivery ticket signed by the owner 
or other comparable document indicating delivery to and acceptance by 
the owner.
    (3) Exceptions. The tax imposed by section 4051(b)(1) and paragraph 
(c)(1) of this section shall not apply if:
    (i) The part or accessory intalled is a replacement part or 
accessory, or
    (ii) The aggregate price of the parts and accessories (and their 
installation) described in paragraph (c)(1) of this section with respect 
to any vehicle does not exceed $200.

For purposes of paragraph (c)(3)(i) of this section, a part is a 
replacement part, regardless of when it is ordered, if its use with a 
vehicle is as a replacement for a part on such vehicle. For purposes of 
paragraph (c)(3)(ii) of this section, the term aggregate price of parts 
and accessories (and their installation) refers to all purchases and 
installation charges, not including replacement parts and accessories, 
made with respect to a vehicle within the 6 month period provided for in 
paragraph (c)(1) of this section. If the aggregate price of parts and 
accessories (and their installation) during the 6 month period exceeds 
$200, the tax imposed under section 4051(b)(1) and paragraph (c)(1) of 
this section shall apply to the cost of all parts and accessories (and 
their installation) during such period. For example, a vehicle is 
purchased and placed in service on July 1, 1983. On August 1, 1983, the 
owner purchases and has installed parts and accessories at a cost of 
$150. On September 1, 1983, the owner purchases and has installed parts 
and accessories at a cost of $300. On September 1, 1983 a tax of $54 
will be imposed (12 percent x $450). Any costs of additional parts and 
accessories installed with respect to the vehicle before January 1, 1984 
(and the cost of installation) will also be subject to the 12 percent 
tax.
    (d) Transitional rule. In the case of an article taxable under 
paragraph (a)(1) of this section, on which a tax was imposed under 
section 4061(a)(1), the rate of tax set forth in paragraph (b) shall be 
applied by substituting ``2 percent'' for ``12 percent.'' For example, 
if a manufacturer sells a tractor to a dealer on February 1, 1983, for 
$20,000 (which includes the Federal excise tax), for which a 10 percent 
tax was paid, and the dealer sells the tractor on April 10, 1983 for 
$25,000, a tax of 2 percent will be imposed on the $25,000 sales price. 
See paragraphs (d) (1) through (4) of Sec. 145.4052-1 relating to 
determination of price.
    (e) Definitions. For purposes of this section:
    (1) Tractor. (i) The term ``tractor'' means a highway vehicle 
primarily designed to tow a vehicle, such as a trailer or semitrailer, 
but does not carry cargo on the same chassis as the engine. A vehicle 
equipped with air brakes and/or towing package will be presumed to be 
primarily designed as a tractor.
    (ii) An incomplete chassis cab shall be treated as a tractor if it 
is equipped with one or more of the following:
    (A) A device for supplying pressure from the chassis cab to the 
brake system (air or hydraulic) of the towed vehicle;
    (B) A mechanism for protecting the chassis cab brake system from the 
effects of a loss of pressure in the brake system of the towed vehicle;
    (C) A control linking the brake system of the chassis to the brake 
system of the towed vehicle;
    (D) A control in the cab for operating the towed vehicle's brakes 
independently of the chassis cab's brakes; or
    (E) Any other equipment designed to make it suitable for use as a 
tractor.

An incomplete chassis cab which is not equipped with any of the devices 
set forth in paragraphs (e)(1)(ii) (A) through (E) of this section shall 
be treated as a truck if the purchaser certifies in writing that the 
vehicle will not be equipped for use as a tractor.
    (2) Truck. The term ``truck'' refers to a highway vehicle that is 
primarily designed to transport its load on the same chassis as the 
engine even if it is also equipped to tow a vehicle, such as a trailer 
or semitrailer.

[[Page 559]]

    (3) Gross vehicle weight. (i) For purposes of this section the term 
``gross vehicle weight'' means the maximum total weight of a loaded 
vehicle. Except as otherwise provided in paragraphs (e)(3) (ii) through 
(v) of this section, such maximum total weight shall be the gross 
vehicle weight rating of the article as specified by the manufacturer or 
established by the seller of the completed article, unless the 
Commissioner finds that such rating is unreasonable in light of the 
facts and circumstances in a particular case.
    (ii) A seller must specify or establish a weight rating for each 
chassis, body, or vehicle sold on or after April 1, 1983 if such article 
requires no additional manufacture other than (A) the addition of 
readily attachable articles, such as tire or rim assemblies or minor 
accessories, (B) the performance of minor finishing operations, such as 
painting, or (C) in the case of a chassis, the addition of a body. If an 
article is specially equipped to the purchaser's specifications, such 
specifications may be used to establish the gross vehicle weight of the 
article.
    (iii) A seller shall maintain a record of the gross vehicle weight 
rating of each truck, trailer and semitrailer sold and excluded from the 
tax imposed by section 4051(a)(1) by reason of sections 4051(a) (2), (3) 
and paragraphs (e)(3) (i) through (v) of this section. For this purpose, 
a record of the serial number of each such article shall be treated as a 
record of the gross vehicle weight rating of the article if such rating 
is indicated by the serial number.
    (iv) If (A) the seller's rating indicated in a label or identifying 
device affixed to an article, (B) the rating set forth in the sales 
invoice or warranty agreement, and (C) the advertised rating for that 
article (or two or more identical articles) are inconsistent, the 
highest of such ratings will be considered to be the seller's gross 
vehicle weight rating specified or established for purposes of the tax 
imposed by section 4051(a)(1).
    (v) The seller's gross vehicle weight rating must take into account, 
among other things, the strength of the chassis frame and the axle 
capacity and placement. The Commissioner may exclude from the gross 
vehicle weight rating any readily attachable parts to the extent the 
Commissioner finds that the use of such parts in computing the gross 
vehicle weight rating is unreasonable.
    (f) Tax-free sales. With respect to tax-free sales of a chassis or 
body for use as a component of a vehicle other than a highway vehicle, 
similar provisions to paragraphs (e)(2) (ii), (iii), and (iv) of Sec. 
48.4061(a)-1 shall apply.
    (g) Effective date. The provisions of this section shall be 
effective for articles sold on or after April 1, 1983.

[T.D. 7882, 48 FR 14362, Apr. 4, 1983, as amended by T.D. 8879, 65 FR 
17164, Mar. 31, 2000]



Sec. 145.4052-1  Special rules and definitions.

    (a) First retail sale--(1) General rule. For purposes of section 
4051(a)(1) and Sec. 145.4051-1, the term ``first retail sale'' means a 
taxable sale described in paragraph (a)(2) of this section.
    (2) Taxable sale. The sale of an article is a taxable sale unless--
    (i) The sale is a tax-free sale under section 4221,
    (ii) [Reserved]. For sales after June 30, 1998, see Sec. 48.4052-1 
of this chapter.
    (iii) There has been a prior taxable sale of the article. 
Notwithstanding the preceding clause, the sale of a chassis or body of a 
trailer or semitrailer (``trailer or semitrailer'') less than six months 
after a taxable sale of the article shall be treated as a taxable sale.
    (3) Computation of tax--(i) In general. If the sale of an article is 
a taxable sale under paragraph (a)(2) of this section, the tax shall be 
computed on the price as determined under paragraph (d) of this section.
    (ii) Exception. If the taxable sale of an article is a taxable use 
of such article under paragraph (c) of this section, the tax shall be 
computed on the price as determined under paragraph (c) of this section.
    (4) Special rule for tax-paid trailer and semitrailer. In the case 
of a taxable sale of a trailer or semitrailer less than six months after 
a taxable sale of the article, the seller in the subsequent sale (``the 
subsequent seller'') may claim a credit equal to the amount of tax 
previously paid by another person (``the previous taxpayer'') under 
section 4051(a)(1) with respect to the prior taxable sale of the 
article. The credit for

[[Page 560]]

such tax will be allowed to the subsequent seller only if the form on 
which the credit is claimed is accompanied by a statement, signed by the 
subsequent seller, indicating the amount of the credit being claimed 
under this paragraph (a)(4) and stating that--
    (i) The subsequent seller has not been repaid any portion of such 
tax by the previous taxpayer,
    (ii) The subsequent seller has not provided the previous taxpayer 
with written consent to allow the previous taxpayer to claim a credit or 
refund of such tax under section 6416 (a), and
    (iii) The subsequent seller has records (e.g., invoices) 
substantiating the amount of tax paid by the previous taxpayer with 
respect to the prior taxable sale of such article.

In no case shall the amount of the credit allowable under this paragraph 
(a)(4) with respect to an article exceed the tax liability of the 
subsequent seller with respect to the sale of such article.
    (5) No installment payments of tax. If a lease or an installment 
sale (or another form of sale under which the sales price is paid in 
installments) is, or is deemed to be, a taxable sale under this section, 
then the liability for the entire tax arises at the time of the lease or 
installment sale. No portion of the tax is deferred by reason of the 
fact that the sales price is paid in installments.
    (6) Certificate. A certificate signed by the purchaser, or an 
officer or employee authorized by the purchaser to sign the certificate, 
may be accepted by a seller in support of a nontaxable sale to the 
purchaser. If it is impracticable to furnish a separate certificate for 
each sale because of the frequency of sales to such purchaser, a 
certificate covering all orders between given dates (such period not to 
exceed 12 calendar quarters) will be acceptable. The purchaser may 
revoke the certificate by sending a written revocation to the seller. 
The certificate and proper records of invoices, orders, etc., relating 
to sales made pursuant to such certificate, must be retained by the 
seller as provided in section 6001 and the regulations thereunder. The 
certificate shall be substantially in the following form:

                          Exemption Certificate

    I hereby certify that I am ------------ (Title) of ------------, 
(Name of purchaser) that I am authorized to execute this certificate, 
and that:
    (Check appropriate line)
------ the article or articles specified in the accompanying order, or 
on the reverse side hereof, (or)
------ all orders placed by the purchaser for the period commencing ----
---------- (Date) (period not to exceed 12 calendar quarters), are 
purchased either for resale or for lease on a long-term basis.
    I have filed Form 637 and have received registration number ------
--.
I understand that the fraudulent use of this certificate to secure 
exemption will subject me and all parties making such fraudulent use to 
a fine of not more than $10,000, or to imprisonment for not more than 5 
years, or both, together with costs of prosecution.

________________________________________________________________________
(Signature)

________________________________________________________________________
(Address)

    (b) Tax treatment of leases--(1) Long-term lease. For purposes of 
this section and Sec. 145.4051-1, the leasing of an article on a long-
term basis (as defined in paragraph (d)(6) of this section) will be 
deemed to be a sale of the article and will be deemed to be a taxable 
sale unless one of the exceptions contained in paragraph (a)(2) of this 
section applies. Thus, if a dealer purchases an article tax-free under 
an exception contained in paragraph (a)(2) of this section and then 
leases the article on a long-term basis, the leasing of the article will 
be treated as a taxable sale.
    (2) Short-term lease. For purposes of this section and Sec. 
145.4051-1, the leasing of an article on a short-term basis (as defined 
in paragraph (d)(6) of this section) will be deemed to be a taxable use 
of such article under paragraph (c) of this section and will be deemed 
to be a taxable sale unless one of the exceptions contained in paragraph 
(a)(2) of this section applies.
    (3) Computation of tax--(i) Long-term lease by manufacturer, 
producer, or importer. When a manufacturer, producer, or importer is the 
lessor of an article on a long-term basis (as defined in paragraph 
(d)(6) of this section) and such lease is deemed to be a taxable sale 
under paragraph (b)(1) of this section, the tax shall be computed on a

[[Page 561]]

presumptive retail sales price as determined under paragraph (d)(4)(i) 
of this section. The manufacturer, producer, or importer shall be liable 
for the tax as if the article were sold at retail by such manufacturer, 
importer, or retailer.
    (ii) Long-term lease by persons other than manufacturer, producer, 
or importer. When a person other than a manufacturer, producer, or 
importer is the lessor of an article on a long-term basis (as defined in 
paragraph (d)(6) of this section) and such lease is deemed to be a 
taxable sale under paragraph (b)(1) of this section, the tax shall be 
computed on a presumptive retail sales price as determined under 
paragraph (d)(5) (i) of this section. Such person shall be liable for 
the tax as if the article were sold at retail by such person.
    (c) Use treated as sale--(1) In general. For purposes of this 
section and Sec. 145.4051-1, the use of an article will be deemed to be 
a sale of the article. Furthermore, if a person purchases a vehicle for 
which no tax was imposed under section 4051(a)(1) and thereafter 
converts such vehicle into an article which would have been taxable 
under section 4051(a)(1) and uses it, such person shall be liable for 
the tax as if such article were sold at retail by such person. For 
example, a truck having a gross vehicle weight rating of 24,000 pounds 
is sold at retail. The purchaser adds a lift axle, thereby increasing 
the gross vehicle weight rating to 34,000 pounds. If the purchaser 
thereafter uses the vehicle the purchaser shall be liable for the tax as 
if such article were sold at retail.
    (2) Exemption for use in further manufacture. The tax on the use of 
an article to which paragraph (c)(1) of this section applies shall not 
apply to use of the article by such person as material in the 
manufacture or production of, or as a component part of, another article 
to be manufactured or produced by the same user.
    (3) Time of application of tax. In the case of taxable use of an 
article by the seller, the tax attaches at the time such use begins. It 
tax applies by reason of the sale of an article on or in connection 
with, or with the sale of another article, the tax attaches at the time 
of the sale of such other article.
    (4) Events subsequent to taxable use of article. Liability for tax 
incurred on the use of an article is not extinguished or reduced because 
of any subsequent sale or lease of the article even if such sale or 
lease would have been exempt if the article had been sold or leased 
prior to use. If a seller of an article incurs liability for tax on his 
or her use of an article, and thereafter sells or leases the article in 
a transaction which otherwise would be subject to tax, liability for tax 
is not incurred on such sale or lease.
    (5) Computation of tax. (i) Except as provided in paragraphs 
(c)(5)(ii) and (c)(5)(iii) of this section.
    (ii) If the seller of an article regularly sells such articles at 
retail in arm's length transactions, tax liability on its use of any 
such article shall be computed on its lowest established retail price 
for such articles in effect at the time of the taxable use. In 
establishing such price, there shall be included and excluded, as 
applicable, the charges and readjustments specified in sections 4216(a), 
4216(f), and 6416(b)(1) as in effect at the time the tax liability on 
the use of the article is incurred. If the seller of an article does not 
regularly sell such articles at retail in arm's length transactions, a 
constructive price on which the tax shall be computed will be determined 
by the Commissioner. This price will be established after considering 
the selling practices and price structures of sellers of similar 
articles.
    (iii) In the case of any short-term lease (as defined in paragraph 
(d)(6) of this section) by any person other than a manufacturer, 
producer, or importer (or related person as defined in paragraph 
(d)(2)(ii) of this section) of an article that is deemed to be a taxable 
use of such article under paragraph (b)(2) of this section, the tax 
imposed by section 4051(a)(1) shall be computed on a price equal to the 
sum of--
    (A) The price (as determined under paragraph (d) of this section) at 
which such article was sold to the lessor plus the cost of any parts and 
accessories installed by the lessor (or an agent of the lessor) on such 
article before the first use or lease by the lessor, plus

[[Page 562]]

    (B) The product of the sum described in paragraph (c)(5)(iii)(A) of 
this section and the presumed markup percentage (as defined in paragraph 
(d)(7) of this section).
    (d) Determination of price--(1) In general. The price for which an 
article is sold includes the total consideration paid for the article 
whether that consideration is paid in money, services, or other forms. 
In addition, there shall be included any charge incident to placing the 
article in condition ready for use. Similar rules to section 4216(a) and 
the regulations thereunder, relating to charges to be included in the 
price and excluded from the price, shall apply. For example, charges for 
transportation, delivery, insurance, and installatioin (other than 
installation charges to which section 4051(b) applies), and other 
expenses actually incurred in connection with the delivery of an article 
to a purchaser pursuant to a bona fide sale shall be excluded from the 
price in computing the tax.
    (2) Presumptive retail sales price where tax paid by manufacturer, 
producer, or importer--(i) In general. In the case of a taxable sale 
(other than a taxable sale described in paragraph (b)(1) of this 
section) where a manufacturer, producer, importer, or related person is 
liable for the tax imposed by section 4051, such tax shall be computed 
on a price equal to the sum of--
    (A) The price that would (but for this paragraph (d)(2)) be 
determined under this paragraph (d), and
    (B) The product of the price determined under paragraph (d)(2)(i)(A) 
of this section and the presumed markup percentage (as defined in 
paragraph (d)(7) of this section).
    (ii) Related person defined--(A) In general. Except as provided in 
paragraph (d)(2)(ii)(B) of this section, the term ``related person'' 
means any person that is a member of the same controlled group (within 
the meaning of section 5061(e)(3)) as the manufacturer, producer, or 
importer.
    (B) Exception for permanent retail establishment. A person shall not 
be treated as a related person with respect to the sale of any article 
if--
    (1) Such person sells the article through a permanent retail 
establishment in the normal course of business of being a retailer, and
    (2) Such person has records (e.g., invoices) that substantiate that 
the article was sold for a price that included a markup equal to or 
greater than the presumed markup percentage (as defined in paragraph 
(d)(7) of this section).
    (3) Retail sales price where tax paid by person other than a 
manufacturer, producer, importer, or related person--(i) In general. In 
the case of a taxable sale (other than a taxable sale defined in 
paragraph (b)(1) of this section) where a person other than a 
manufacturer, producer, importer, or related person is liable for the 
tax imposed by section 4051, such tax shall be computed on a price 
determined under paragraph (d)(1) of this section.
    (ii) Exception. When a person other than a manufacturer, producer, 
importer, or related person is liable for the tax imposed by section 
4051, such tax shall be computed on a price determined under paragraph 
(d)(2)(i) of this section if--
    (A) Such person does not perform any significant activities relating 
to the processing of the sale of an article,
    (B) The principal purpose for processing the sale through such 
person is to avoid or evade the presumed markup under paragraph 
(d)(2)(i)(B) of this section, and
    (C) Such person does not have records (e.g., invoices) 
substantiating that the article was sold for a price that included a 
markup equal to or greater than the presumed markup percentage as 
defined in paragraph (d)(7) of this section.
    (4) Presumptive retail sales price in the case of a lease by a 
manufacturer, producer, or importer. In the case of any long-term lease 
(as defined in paragraph (d)(6) of this section) by a manufacturer, 
producer, importer, or a related person (as defined in paragraph 
(d)(2)(ii) of this section) of an article that is deemed to be a taxable 
sale of such article under paragraph (b)(1) of this section, the tax 
imposed by section 4051(a)(1) shall be computed on a price equal to the 
sum of--
    (i) A constructive sales price established by the Commissioner based 
on the price at which such article would

[[Page 563]]

be sold by a manufacturer, producer, or importer in a sale other than a 
taxable sale (e.g., a sale to which the exceptions contained in 
paragraph (a)(2)(ii) of this section applies) on the date the lease is 
made, and
    (ii) The product of the constructive sales price referred to in 
paragraph (d)(4)(i) of this section and the presumed markup percentage 
as defined in paragraph (d)(7) of this section.
    (5) Presumptive retail sales price in the case of a long-term lease 
by any other person. In the case of any long-term lease (as defined in 
paragraph (d)(6) of this section) of an article in which any person 
other than a manufacturer, producer, or importer (or related person as 
defined in paragraph (d)(2)(ii) of this section) is the lessor and the 
long-term lease is deemed to be a taxable sale of such article under 
paragraph (b)(1) of this section, the tax imposed by section 4051(a)(1) 
shall be computed on a price equal to the sum of--
    (i) The price (as determined under this paragraph (d)) at which such 
article was sold to the lessor plus the cost of any parts and 
accessories installed by the lessor (or an agent of the lessor) on such 
article before the first use by the lessee or leased in connection with 
such long-term lease, and
    (ii) The product of the sum described in paragraph (d)(5)(i) of this 
section and the presumed markup percentage as defined in paragraph 
(d)(7) of this section.
    (6) Long-term and short-term lease defined. For purposes of this 
section, the term ``long-term lease'' means any lease with a term of one 
year or more. The term ``short-term lease'' means any lease with a term 
of less than one year. In determining a lease term, options to renew 
shall be taken into account. In addition, two or more successive leases 
that are part of the same transaction (or a series of related 
transactions) with respect to the same or substantially similar article, 
shall be treated as one lease.
    (7) Presumed markup percentage--(i) In general. Except as provided 
in paragraph (d)(7)(ii) of this section, for purposes of this section 
the term ``presumed markup percentage'' shall be four percent.
    (ii) Exceptions. For purposes of this section the ``presumed markup 
percentage'' for trailers, semitrailers, and remanufactured automobile 
truck chassis and bodies and tractors shall be zero percent. For 
purposes of this section an article is a remanufactured article if--
    (A) The refurbishing, renovation, or repair of the article causes it 
to be subject to the tax imposed by section 4051, and
    (B) Before remanufacture, such article was previously subject to the 
tax imposed by section 4051 (or section 4061 prior to its repeal).
    (8) Items excluded from price. There shall be excluded from the 
price:
    (i) The amount ot tax imposed under sections 4051(a)(1) and (b)(1);
    (ii) If stated as a separate charge, the amount of any retail sales 
tax imposed by any state or political subdivision thereof or the 
District of Columbia, whether the liability for such tax is imposed on 
the vendor or vendee; and
    (iii) The fair market value (including any tax imposed by section 
4071) at retail of any tires (not including any metal rim or rim base). 
For purposes of this paragraph (d)(8)(iii), fair market value at retail 
shall be determined by the lowest established price for which the 
vehicle retailer would sell such tires at retail in the ordinary course 
of trade. The lowest established price is the lowest price for which the 
vehicle retailer sells, or offers to sell, a single tire to an 
independent purchaser who would not ordinarily be expected to buy more 
than one. If the vehicle retailer has no lowest established price the 
Commissioner will accept any price provided, under the facts and 
circumstances, such price is not unreasonable. For vehicles sold on or 
after April 1, 1983, and before October 13, 1985, a price will not be 
considered unreasonable if it is no more than an amount equal to 50 
percent of the manufacturer's suggested retail price.
    (9) Trade-ins. If, in connection with the sale of an article subject 
to the tax imposed under section 4051(a)(1) or (b)(1) on the price for 
which sold, a vendor receives from its vendee another article in 
exchange, the tax on the vendor's sale shall be computed on the basis of 
the full price of the article

[[Page 564]]

sold, unreduced by any amount allowed for the article received from the 
vendee. For example, where a vehicle costing $20,000 is purchased for 
$16,000 cash plus a used vehicle valued at $4,000, tax is $2,400 (12 
percent x $20,000).
    (10) Sales not at arm's length. For purposes of Sec. 145.4051-1 and 
this section, a sale is considered to be made under circumstances 
otherwise than at ``arm's length'' if:
    (i) One of the parties is controlled (in law or in fact) by the 
other, or there is common control, whether or not such control is 
actually exercised to influence the sale price, or
    (ii) The sale is made pursuant to special arrangements between a 
seller and a purchaser.

In the case of an article sold otherwise than at arm's length, and sold 
at less than the fair market price, the tax imposed under section 
4051(a)(1) or (b)(1) shall be computed on the price for which similar 
articles are sold at retail in the ordinary course of trade, as 
determined by the Commissioner. Once such a price has been determined, 
no further adjustment of such price shall be made.
    (e) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. M manufactures trucks that are taxable under section 
4051. On July 11, 1988, D, a corporation that is a dealer, purchases one 
truck from M for $50,000. M does not own any stock in D. Prior to this 
transaction, D gave M a certificate that meets the specifications 
detailed in paragraph (a)(6) of this section. The certificate states 
that the truck will be resold or leased on a long-term basis. M's sale 
to D is not a taxable sale of the truck (within the meaning of paragraph 
(a)(2) of this section). On July 20, 1988, D resells the truck to a 
purchaser, P, for $52,000. The additional $2,000 includes the dealer's 
mark-up, costs of transporting the truck from M to D, and overhead. No 
parts or accessories were added to the truck. P did not give D a 
certificate and did not have an agreement with D under which all 
vehicles purchased were to be resold. The sale of the truck by D to P is 
a taxable sale within the meaning of paragraph (a)(3) of this section. 
Therefore, D has a tax liability of $6,240 (12%x$52,000).
    Example 2. Assume the same facts as in example (1) except that M 
owns 80 percent of D's stock. D and M are members of the same controlled 
group (within the meaning of section 5061(e)(3)). Therefore, D is a 
related person under paragraph (d)(2)(ii)(A) of this section. On July 
20, 1988, D sells the truck to P for $51,000. D does not have records 
substantiating that the truck was sold for a price that included a 
markup equal to or greater than the presumed markup percentage. The tax 
on the sale of the truck to P is determined under paragraph (d)(2)(i) of 
this section. Therefore, D has a tax liability of $6,240 
[(12%x($50,000+($50,000x4%))].
    Example 3. Assume the same facts as in example (1) except that D 
does not perform any significant activities relating to the sale. Assume 
further that the principal purpose for processing the sale through D is 
to avoid the presumed markup and that D did not sell the truck for a 
price that included a markup equal to or greater than the presumed 
markup percentage. D, however, is designated the seller of the truck on 
the invoice. Pursuant to paragraph (d)(3)(ii) of this section, the price 
of the truck shall be computed on a price determined under paragraph 
(d)(2)(i). Therefore, D, the taxpayer, has a tax liability of $6,240 
[12%x($50,000+($50,000x4%))].
    Example 4. Assume the same facts as in example (1) except that on 
July 20, 1988, D leases the truck for a two-year period (i.e., on a 
long-term basis) to L, a lessee. D's leasing of the truck to L is 
treated as a taxable sale under paragraph (b)(1) of this section and the 
tax is computed on the price as determined under paragraph (d)(5)(i) of 
this section. D has a tax liability of $6,240 
[12%x($50,000+($50,000x4%))].
    Example 5. Assume the same facts as in example (1) except that on 
July 20, 1988. D leases the truck to L for a six-month period (i.e., a 
short-term lease). The lease is treated as a use under paragraph (b)(2) 
of this section. The tax is computed on the price as determined under 
paragraph (c)(5) of this section. D has a tax liability of $6,240 
[12%x($50,000+($50,000x4%))].
    Example 6. Assume the same facts as in example (1) except that D 
does not give M a certificate. The sale by M to D is a taxable sale of 
the truck under paragraph (a)(2) of this section. M's tax liability is 
$6,240 [12%x($50,000+($50,000x4%))]. On July 20, 1988, D leases the 
truck to L, a lessee. The lease has a two-year term. Since the lease to 
L occurred after a taxable sale of the truck, paragraph (b)(1) of this 
section does not apply, and the lease is not treated as a taxable sale 
under this section.
    Example 7. M manufactures trucks that are taxable under section 
4051. On July 11, 1988, M leases a truck to a lessee, L. The lease has a 
two-year term. The lease is treated as a taxable sale under paragraph 
(b)(1) of this section and the tax is computed on the price as 
determined under paragraph (d)(4)(i) of this section. The constructive 
sales price established by the Commissioner, pursuant to paragraph 
(d)(4)(i) of this section, is $50,000.

[[Page 565]]

M has a tax liability of $6,240 [12%x($50,000+($50,000x4%))].
    Example 8. Assume the same facts as in example (7) except that the 
lease has a six-month term. The lease is treated as a taxable use under 
paragraph (b)(2) of this section and the tax is computed under paragraph 
(c)(5) of this section. The constructive sales price established by the 
Commissioner, pursuant to paragraph (c)(5)(i) of this section, is 
$52,000. M has a tax liability of $6,240 (12%x$52,000).
    Example 9. M manufactures truck trailers and semitrailers that are 
taxable under section 4051. On July 5, 1988, D, a dealer, purchases a 
trailer from M for $10,000. Prior to this transaction, D did not give M 
a certificate and D did not have an agreement with M to resell all 
articles purchased. The sale by M to D is a taxable sale of the trailer 
under paragraph (a)(2) of this section. M has a tax liability of $1,200 
(12%x$10,000+($10,000x0%)).
    Example 10. Assume the same facts as in example (9) except that on 
July 12, 1988, D resells the trailer to P, a purchaser, for $10,500 (the 
additional $500 includes the dealer's markup, costs of transporting the 
trailer from M to D, and overhead). P did not give D a certificate and P 
did not have an agreement with D that stipulates that all articles 
purchased were to be leased on a long-term basis or resold. The sale of 
the trailer by D to P is a taxable sale within the meaning of paragraph 
(a)(3) of this section. Therefore, D has a tax liability of 
$1,260(12%x$10,500). D, however, may file for a credit of $1,200 under 
section 6402 provided that the requirements of paragraph (a)(4) of this 
section are met.

    (f) Other rules made applicable. For purposes of Sec. 145.4051-1 
and this section, rules similar to the following provisions shall apply:
    (1) Section 48.0-2, relating to general definitions and attachment 
of tax;
    (2) Paragraphs (a) (2) and (3) of Sec. 48.4061 (a)-1;
    (3) The exemptions provided by sections 4063 (a) and (d) and the 
regulations thereunder;
    (4) Section 4216(f) and the regulations thereunder, relating to the 
incorporation of used components; and
    (5) Section 4221 and the regulations thereunder, relating to certain 
tax-free sales.
    (g) Effective date--(1) In general. Except as provided below, the 
provisions of this section shall be effective for articles sold or 
leased on or after April 1, 1983.
    (2) Certain sales made prior to November 12, 1985. If a sale to a 
lessor before November 12, 1985, was not taxable under Sec. 145.4052-1 
of the temporary regulations contained in 26 CFR part 145 revised as of 
April 1, 1983, (the ``prior regulations'') and it was so treated by the 
parties, a subsequent sale or lease that was or would have been treated 
as the first retail sale of the article under the prior regulations will 
be treated as a taxable sale for purposes of this section. The tax on 
such subsequent sale will be based on a price determined under paragraph 
(d) of this section. For example, if an article was sold to a purchaser 
who intended to lease such article long-term, the sale would not have 
been taxable under the prior regulations even though the seller did not 
receive a certificate of the purchaser's intent to lease the vehicle. If 
such a sale was treated as nontaxable by the parties, and the purchaser 
leases it long-term on or after October 1, 1987, the lease will be 
treated as a taxable sale of the article. The tax is to be computed 
under paragraph (b)(3)(ii) of this section and the price will be 
computed under paragraph (d)(5).
    (3) Certain sales made after November 11, 1985, and before October 
1, 1987--(i) Sales not treated as taxable by purchaser and seller. If a 
sale to a purchaser after November 11, 1985, and before October 1, 1987, 
was not treated as taxable by the parties, a subsequent sale or lease 
that was or would have been treated as the first retail sale of the 
article under the temporary regulations published in the September 13, 
1985, issue of the Federal Register (50 FR 37350) (``the interim 
regulations'') will be treated as a taxable sale for purposes of this 
section. The tax on a sale or lease after September 30, 1987, will be 
based on a price determined under paragraph (d) of this section. For 
example, if a vehicle was sold on January 3, 1987, to a purchaser who 
intended to resell the article and who was not in the business of 
leasing to any extent, the sale would not have been taxable under the 
interim regulations even though the seller did not receive a certificate 
indicating the purchaser's intent to resell the article. If such a sale 
was not treated as a taxable sale by the parties, and the purchaser 
resells the article, the resale will be treated as a taxable sale

[[Page 566]]

of the article under paragraph (a)(2) of this section.
    (ii) Sales treated as first retail sale by purchaser and seller. If 
the sale of an article after November 11, 1985, and before October 1, 
1987, was treated as a taxable sale by the parties and tax was paid with 
respect to the article under the interim regulations, the subsequent 
sale of the article by the purchaser will not be treated as a taxable 
sale under paragraph (a)(2) of this section.

[T.D. 7882, 48 FR 14362, Apr. 4, 1983, as amended by T.D. 8050, 50 FR 
37351, Sept. 13, 1985; T.D. 8200, 53 FR 16869, May 12, 1988; T.D. 8774, 
63 FR 35804, July 1, 1998; T.D. 8879, 65 FR 17164, Mar. 31, 2000]



Sec. 145.4061-1  Application to manufacturers tax.

    The provisions of Sec. 145.4051-1(e) (1) and (2), relating to the 
definition of tractors and trucks, shall apply to section 4061(a)(1) for 
sales made on or after January 7, 1983. However, an incomplete chassis 
cab will be treated as a truck chassis for sales made on or after 
January 7, 1983, and before April 1, 1983. For purposes of section 4061, 
gross vehicle weight shall be determined under Sec. 48.4061(a)-1(f)(3) 
(i) through (iv) for sales made on or after January 7, 1983, and before 
April 1, 1983.



PART 148_CERTAIN EXCISE TAX MATTERS UNDER THE EXCISE TAX TECHNICAL
CHANGES ACT OF 1958--Table of Contents



    Authority: 26 U.S.C. 7805.



Sec. 148.1-5  Constructive sale price.

    (a) Purpose of this section. The purpose of this section is to set 
forth temporary rules to be used in determining a constructive sale 
price under section 4216(b) of the Internal Revenue Code, as amended by 
section 115 of the Excise Tax Technical Changes Act of 1958, with 
respect to certain sales made on and after January 1, 1959, by a 
manufacturer, producer, or importer. The temporary rules set forth in 
this section have application in the case of articles in respect of 
which the manufacturer's excise tax imposed under Chapter 32 of the Code 
is based on the price for which the article is sold.
    (b) General rule--(1) Sales at retail. Where a manufacturer, 
producer, or importer sells an article at retail, and the special rule 
provided in paragraph (c) of this section does not apply, the basis for 
tax shall be the lower of: (i) the actual price for which the article is 
sold; or (ii) the highest price for which such articles are sold to 
wholesale distributors, in the ordinary course of trade, by 
manufacturers or producers thereof. Thus, where a manufacturer, 
producer, or importer sells an article at retail, the tax on his retail 
sale ordinarily will be computed upon the highest price for which 
similar articles are sold by him to wholesale distributors. However, in 
such cases it must be shown that he has an established bona fide 
practice of selling such articles in substantial quantities to wholesale 
distributors. If he has no such sales to wholesale distributors, a fair 
market price will be determined by the Commissioner. In any case the 
price so determined shall not be in excess of the actual price for which 
the article is sold by him at retail.
    (2) Sales on consignment and sales otherwise than through an arm's 
length transaction. For rules relating to the determination of a 
constructive sale price in the case of sales on consignment, or sales 
otherwise than through an arm's length transaction and at less than the 
fair market price, see paragraphs (a) and (d) of Sec. 316.15 of 
Regulations 46 (26 CFR (1939) part 316), as prescribed under and made 
applicable to the Internal Revenue Code of 1954 by Treasury Decision 
6091, 19 FR 5167, August 17, 1954.
    (c) Special rule--(1) Basis for tax. Where a manufacturer, producer, 
or importer sells an article at retail, to a retailer, or to a special 
dealer, and the conditions specified in subparagraph (2) of this 
paragraph are met, a special constructure sale price rule is provided 
for computation of the tax. This rule provides that the tax is to be 
based on the lower of the following prices: (i) The actual price for 
which the article is sold; or (ii) the highest price for which such 
articles are sold by such manufacturer, producer, or importer to

[[Page 567]]

wholesale distributors (other than special dealers).
    (2) Conditions governing applicability of special rule. In order to 
qualify for application of the special constructive sale price rule to 
the sale by the manufacturer, producer, or importer of an article at 
retail, to a retailer, or to a special dealer, the following four 
conditions must be satisfied.
    (i) The manufacturer, producer, or importer of the article must 
regularly sell such articles at retail, to retailers, or to special 
dealers, as the case may be.
    (ii) The manufacturer, producer, or importer of the article must 
regularly sell such articles to one or more wholesale distributors 
(other than special dealers) in arm's length transactions, and must 
establish that his prices in such cases are determined without regard to 
any tax benefit under this paragraph resulting from a reduction in the 
tax base for his sales at retail, to retailers, or to special dealers.
    (iii) The normal method of sales within the industry embracing the 
article is not to sell at retail, or to retailers, or both.
    (iv) The sale at retail, to a retailer, or to a special dealer must 
be an arm's length transaction.
    (3) Requests for determination. In any case in which a manufacturer, 
producer, or importer desires a determination as to the application of 
this paragraph, he may request such a determination from the 
Commissioner. The request shall contain complete and detailed 
information with respect to each of the conditions specified in 
subparagraph (2) of this paragraph to assist the Commissioner in 
determining whether the constructive sale price provisions of this 
paragraph apply, such as data which will show the normal method of sales 
for the article within the industry by manufacturers, producers, and 
importers (including the dollar volume of sales at various distribution 
levels), and the source of such data; evidence as to the regularity with 
which sales of such articles are made by the manufacturer, producer, or 
importer at retail, to retailers, or to special dealers; information 
that the prices of the manufacturer, producer, or importer to wholesale 
distributors have been determined without regard to any tax benefit 
under the special rule of this paragraph; etc.
    (d) Definitions. For purposes of this section:
    (1) Wholesale distributors. The term ``wholesale distributors'' 
means persons who customarily resell to others who in turn resell.
    (2) Special dealer. The term ``special dealer'' means a distributor 
of articles taxable under section 4121 (relating to electric, gas, and 
oil appliances) who does not maintain a sales force to resell the 
article whose constructive sale price is established under paragraph (c) 
of this section but relies on salesmen of the manufacturer, producer, or 
importer of the article for resale of the article to retailers.
    (3) Industry. (i) The term ``industry'' as applied to any article 
generally means the specific category of articles listed in Chapter 32 
of the Internal Revenue Code (other than combinations) that embraces the 
article for which a constructive sale price is to be determined under 
paragraph (c) of this section. For the rule applicable to combinations 
of two or more articles, see subdivision (iv) of this subparagraph.
    (ii) The following are examples of categories of taxable articles 
which comprise separate industries:
    (a) Taxable electric flatirons;
    (b) Taxable electric, gas, and oil appliances of the type used for 
cooking, warming, or keeping warm food or beverages for consumption on 
the premises;
    (c) Taxable electric direct-motor and belt-driven fans and air 
circulators;
    (d) Taxable electric, gas, and oil incinerator units and garbage 
disposal units;
    (e) Taxable electric light bulbs and tubes;
    (f) Taxable radio receiving sets;
    (g) Taxable automobile radio receiving sets;
    (h) Taxable radio and television components;
    (i) Taxable musical instruments;
    (j) Taxable fishing rods, creels, reels and artificial lures, baits, 
and flies;
    (k) Taxable golf bags, balls and clubs;
    (l) Taxable cameras;

[[Page 568]]

    (m) Taxable unexposed photographic film in rolls (including motion 
picture film);
    (n) Taxable check writing, signing, cancelling, perforating, 
cutting, and dating machines, and other check protector machine devices;
    (o) Taxable cash registers; and
    (p) Taxable mechanical pencils, fountain pens and ball point pens.
    (iii) With respect to the tax imposed by section 4061, the following 
categories of articles are to be considered separate industries:
    (a) Taxable automobile trucks (consisting of automobile truck bodies 
and chassis);
    (b) Taxable automobile buses (consisting of automobile bus bodies 
and chassis);
    (c) Taxable truck and bus trailers and semitrailers (consisting of 
chassis and bodies of such trailers and semitrailers);
    (d) Taxable tractors of the kind chiefly used for highway 
transportation in combination with a trailer or semitrailer;
    (e) All other taxable automobile chassis and bodies;
    (f) Taxable trailer and semitrailer chassis and bodies suitable for 
use in connection with passenger automobiles; and
    (g) Taxable automobile parts and accessories.
    (iv) With respect to an article which is:
    (a) Taxable as ``Combinations of household type refrigerators and 
quickfreeze units'' under section 4111,
    (b) Taxable as ``Combinations of any of the foregoing'' under 
sections 4141 and 4191, or
    (c) A combination, other than a combination referred to in (a) or 
(b) of this subdivision, of articles taxable under the same section or 
different sections of Chapter 32 of the Code.

The industry test required by paragraph (c)(2)(iii) of this section for 
such article shall be met if such test is met for the article or 
articles which comprise more than 50 percent in value of the 
combination. In case of a combination consisting of a taxable article 
and a nontaxable article, the category for the taxable article in the 
combination shall constitute the industry for purposes of paragraph 
(c)(2)(iii) of this section.

[T.D. 6355, 24 FR 311, Jan. 14, 1959]

                        PARTS 151	155 [RESERVED]



PART 156_EXCISE TAX ON GREENMAIL--Table of Contents



                       Subpart A_Tax on Greenmail

Sec.
156.5881-1 Imposition of excise tax on greenmail.

                 Subpart B_Procedure and Administration

156.6001-1 Notice or regulations requiring records, statements, and 
          special returns.
156.6011-1 General requirement of return, statement, or list.
156.6060-1 Reporting requirements for tax return preparers.
156.6061-1 Signing of returns and other documents.
156.6065-1 Verification of returns.
156.6071-1 Time for filing returns relating to greenmail.
156.6081-1 Automatic extension of time for filing a return due under 
          chapter 54.
156.6091-1 Place for filing chapter 54 (Greenmail) tax returns.
156.6091-2 Exceptional cases.
156.6107-1 Tax return preparer must furnish copy of return and claim for 
          refund to taxpayer and must retain a copy or record.
156.6109-1 Tax return preparers furnishing identifying numbers for 
          returns or claims for refund.
156.6151-1 Time and place for paying of tax shown on returns.
156.6161-1 Extension of time for paying tax or deficiency.
156.6165-1 Bonds where time to pay tax or deficiency has been extended.
156.6694-1 Section 6694 penalties applicable to tax return preparer.
156.6694-2 Penalties for understatement due to an unreasonable position.
156.6694-3 Penalty for understatement due to willful, reckless, or 
          intentional conduct.
156.6694-4 Extension of period of collection when tax return preparer 
          pays 15 percent of a penalty for understatement of taxpayer's 
          liability and certain other procedural matters.
156.6695-1 Other assessable penalties with respect to the preparation of 
          tax returns or claims for refund for other persons.
156.6696-1 Claims for credit or refund by tax return preparers.
156.7701-1 Tax return preparer.


[[Page 569]]


    Authority: 26 U.S.C. 6001, 6011, 6061, 6071, 6091, 6161, and 7805.
    Section 156.6060-1 also issued under 26 U.S.C. 6060(a);
    Section 156.6081-1 also issued under 26 U.S.C. 6081(a);
    Section 156.6109-1 also issued under 26 U.S.C. 6109(a);
    Section 156.6109-2 also issued under 26 U.S.C. 6109(a);
    Section 156.6695-1 also issued under 26 U.S.C. 6695(b).

    Source: T.D. 8379, 56 FR 65685, Dec. 18, 1991, unless otherwise 
noted.



                       Subpart A_Tax on Greenmail



Sec. 156.5881-1  Imposition of excise tax on greenmail.

    (a) In general. Section 5881 of the Code imposes a tax equal to 50 
percent of the gain or other income realized by any person on the 
receipt of greenmail, whether or not the gain or other income is 
recognized.
    (b) Transactions occurring on or after March 31, 1988. For 
transactions occurring on or after March 31, 1988, greenmail is defined 
as any consideration transferred by a corporation (or any person acting 
in concert with the corporation) to directly or indirectly acquire stock 
of the corporation from any shareholder if:
    (1) The transferring shareholder has held the stock (as determined 
under section 1223) for less than two years before entering into the 
agreement to transfer the stock,
    (2) The shareholder, any person acting in concert with the 
shareholder, or any person related to the shareholder or to a person 
acting in concert with the shareholder made or threatened to make a 
public tender offer for stock of the corporation at some time during the 
two-year period ending on the date of the acquisition of the stock by 
the corporation, and
    (3) The acquisition is pursuant to an offer that was not made on the 
same terms to all shareholders.
    (c) Transactions occurring before March 31, 1988. For transactions 
occurring before March 31, 1988, greenmail has the same meaning as in 
paragraph (b) of this section, except that it does not include any 
consideration transferred by any person acting in concert with the 
corporation described in that paragraph.
    (d) Effective date. Generally, section 5881 of the Code applies to 
consideration received after December 22, 1987, in taxable years ending 
after that date. However, section 5881 does not apply to any acquisition 
of stock pursuant to a written binding contract in effect on December 
15, 1987, and at all times thereafter before the acquisition.



                 Subpart B_Procedure and Administration



Sec. 156.6001-1  Notice or regulations requiring records, statements,
and special returns.

    (a) In general. Any person subject to tax under chapter 54 
(Greenmail) of the Code shall keep such complete and detailed records as 
are sufficient to enable the district director to determine accurately 
the amount of liability under chapter 54.
    (b) Notice by district director requiring returns, statements, or 
the keeping of records. The district director may require any person, by 
notice served upon him, to make such returns, render such statements, or 
keep such specific records as will enable the district director to 
determine whether or not the person is liable for tax under chapter 54 
of the Code.
    (c) Retention of records. The records required by this section shall 
be kept at all times available for inspection by authorized internal 
revenue officers or employees, and shall be retained so long as the 
contents thereof may become material in the administration of any 
internal revenue law.

[T.D. 8379, 56 FR 65685, Dec. 18, 1991; 57 FR 5931, Feb. 18, 1992]



Sec. 156.6011-1  General requirement of return, statement, or list.

    Every person liable for tax under section 5881 of the Code shall 
file a return with respect to the tax on the form prescribed by the 
Internal Revenue Service (Form 8725). Each such person shall include 
therein the information required by the form and the instructions issued 
with respect thereto.

[[Page 570]]



Sec. 156.6060-1  Reporting requirements for tax return preparers.

    (a) In general. A person that employs one or more tax return 
preparers to prepare a return or claim for refund under section 5881 of 
the Internal Revenue Code, other than for the person, at any time during 
a return period, shall satisfy the record keeping and inspection 
requirements in the manner stated in Sec. 1.6060-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]



Sec. 156.6061-1  Signing of returns and other documents.

    Any return, statement, or other document required to be made with 
respect to a tax imposed by chapter 54 (Greenmail) of the Code or the 
regulations thereunder shall be signed by the person required to file 
the return, statement, or other document, or by the persons required or 
duly authorized to sign in accordance with the regulations, forms, or 
instructions prescribed with respect to such return, statement, or 
document. An individual's signature on such a return, statement, or 
other document shall be prima facie evidence that the individual is 
authorized to sign the return, statement, or other document.



Sec. 156.6065-1  Verification of returns.

    If a return, statement, or other document made under the provisions 
of chapter 54 (Greenmail) or of subtitle F of the Code, or the 
regulations thereunder with respect to any tax imposed by chapter 54, or 
the form and instructions issued with respect to such return, statement, 
or other document, requires that it shall contain or be verified by a 
written declaration that it is made under the penalties of perjury, it 
must be so verified by the person or persons required to sign such 
return, statement, or other document. In addition, any other statement 
or document submitted under any provision of chapter 54 or of subtitle F 
of the Code, or the regulations thereunder with respect to any tax 
imposed by chapter 54 may be required to contain or be verified by 
written declaration that is made under the penalties of perjury.



Sec. 156.6071-1  Time for filing returns relating to greenmail.

    (a) In general. Returns required by Sec. 156.6011-1 (relating to 
liability for tax on greenmail under section 5881) shall be filed on or 
before the ninetieth day following receipt of any portion of the 
greenmail. Greenmail is considered to be received when gain or other 
income is realized, as determined according to the taxpayer's method of 
accounting, without regard to any provision of the Code providing for 
deferral of recognition.
    (b) Returns relating to greenmail received before the date these 
regulations become final. Returns required by Sec. 156.6011-1 that 
relate to greenmail received on or before December 18, 1991, shall be 
filed on or before March 18, 1992.



Sec. 156.6081-1  Automatic extension of time for filing a return due
under chapter 54.

    (a) In general. A taxpayer required to file a return on Form 8725, 
``Excise Tax on Greenmail,'' will be allowed an automatic 6-month 
extension of time to file the return after the date prescribed for 
filing the return if the taxpayer files an application under this 
section in accordance with paragraph (b) of this section.
    (b) Requirements. To satisfy this paragraph (b), a taxpayer must--
    (1) Submit a complete application on Form 7004, ``Application for 
Automatic Extension of Time to File Certain Business Income Tax, 
Information, and Other Returns,'' or in any other manner prescribed by 
the Commissioner;
    (2) File the application on or before the date prescribed for filing 
the return with the Internal Revenue Service office designated in the 
application's instructions; and
    (3) Remit the amount of the properly estimated unpaid tax liability 
on or before the date prescribed for payment.
    (c) No extension of time for the payment of tax. An automatic 
extension of time for filing a return granted under paragraph (a) of 
this section will not extend the time for payment of any tax due on such 
return.

[[Page 571]]

    (d) Termination of automatic extension. The Commissioner may 
terminate an automatic extension at any time by mailing to the taxpayer 
a notice of termination at least 10 days prior to the termination date 
designated in such notice. The Commissioner must mail the notice of 
termination to the address shown on the Form 7004 or to the taxpayer's 
last known address. For further guidance regarding the definition of 
last known address, see Sec. 301.6212-2 of this chapter.
    (e) Penalties. See section 6651 for failure to file or failure to 
pay the amount shown as tax on the return.
    (f) Effective/applicable dates. This section is applicable for 
applications for an automatic extension of time to file a return due 
under chapter 54, filed after July 1, 2008.

[T.D. 9407, 73 FR 37370, July 1, 2008]



Sec. 156.6091-1  Place for filing chapter 54 (Greenmail) tax returns.

    Except as provided in Sec. 156.6091-2 (relating to exceptional 
cases):
    (a) Individuals, estates, and trusts. In general, tax returns under 
chapter 54 of the Code of individuals, estates, and trusts shall be 
filed with any person assigned the responsibility to receive returns in 
the local Internal Revenue Service office that serves the legal 
residence or the principal place of business of the person required to 
make the return.
    (b) Corporations. In general, tax returns under chapter 54 of the 
Code of corporations shall be filed with any person assigned the 
responsibility to receive returns in the local Internal Revenue Service 
office that serves the principal place of business or the principal 
office or agency of the corporation.
    (c) Partnerships. In general, tax returns under chapter 54 of the 
Code of partnerships shall be filed with any person assigned the 
responsibility to receive returns in the local Internal Revenue Service 
office that serves the principal place of business or the principal 
office or agency of the partnership.
    (d) Returns of taxpayers outside the United States. The return of a 
person (other than a partnership or a corporation) outside the United 
States having no legal residence or principal place of business or 
agency in the United States, or the return of a partnership or a 
corporation having no principal place of business or principal office or 
agency in the United States, shall be filed with the Internal Revenue 
Service, Philadelphia, PA 19255, or as otherwise directed in the 
applicable forms and instructions.
    (e) Returns filed with service centers or by hand carrying. 
Notwithstanding paragraph (a), (b), (c), or (d) of this section, unless 
a return is filed by hand carrying, whenever instructions applicable to 
tax returns under chapter 54 of the Code provide that the returns be 
filed with a service center, the returns must be so filed in accordance 
with the instructions. Returns that are filed by hand carrying shall be 
filed with any person assigned the responsibility to receive hand-
carried returns in the local Internal Revenue Service office in 
accordance with paragraphs (a), (b), (c), or (d) of this section.

[T.D. 8379, 56 FR 65685, Dec. 18, 1991; 57 FR 5931, Feb. 18, 1992, as 
amended by T.D. 9156, 69 FR 55746, Sept. 16, 2004]



Sec. 156.6091-2  Exceptional cases.

    Notwithstanding the provisions of Sec. 156.6091-1, the Commissioner 
may permit the filing of any tax return under chapter 54 (Greenmail) of 
the Code in any local Internal Revenue Service office.

[T.D. 8379, 56 FR 65685, Dec. 18, 1991, as amended by T.D. 9156, 69 FR 
55747, Sept. 16, 2004]



Sec. 156.6107-1  Tax return preparer must furnish copy of return and
claim for refund to taxpayer and must retain a copy or record.

    (a) In general. A person who is a signing tax return preparer of any 
return or claim for refund of tax under section 5881 of the Internal 
Revenue Code shall furnish a completed copy of the return or claim for 
refund to the taxpayer and retain a completed copy or record in the 
manner stated in Sec. 1.6107-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and

[[Page 572]]

claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]



Sec. 156.6109-1  Tax return preparers furnishing identifying numbers
for returns or claims for refund.

    (a) In general. Each tax return or claim for refund for tax under 
section 5881 of the Internal Revenue Code prepared by one or more 
signing tax return preparers must include the identifying number of the 
preparer required by Sec. 1.6695-1(b) of this chapter to sign the 
return or claim for refund in the manner stated in Sec. 1.6109-2 of 
this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed after December 31, 
2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]



Sec. 156.6151-1  Time and place for paying of tax shown on returns.

    The tax under chapter 54 (Greenmail) of the Code shown on any return 
shall, without notice of assessment and demand, be paid to the internal 
revenue officer with whom the return is filed at the time and place for 
filing such return (determined without regard to any extension of time 
for filing the return). For provisions relating to the time and place 
for filing such return, see Sec. Sec. 156.6071-1 and 156.6091-1. For 
provisions relating to the extension of time for paying the tax, see 
Sec. 156.6161-1.



Sec. 156.6161-1  Extension of time for paying tax or deficiency.

    (a) In general--(1) Tax shown or required to be shown on return. A 
reasonable extension of the time for payment of the amount of any tax 
imposed by chapter 54 (Greenmail) of the Code and shown or required to 
be shown on any return may be granted by the appropriate district 
director at the request of the taxpayer. The period of such extension 
shall not exceed 6 months from the date for payment of such tax.
    (2) Deficiency. The time for payment of any amount determined as a 
deficiency in respect of tax imposed by chapter 54 of the Code may, at 
the request of the taxpayer, be extended by the internal revenue officer 
to whom the tax is required to be paid. The extension may be for a 
period not to exceed 18 months from the date fixed for payment of the 
deficiency, as shown on the notice and demand. In exceptional cases, a 
further extension for a period not in excess of 12 months may be 
granted. No extension of time for payment of a deficiency shall be 
granted if the deficiency is due to negligence, to intentional disregard 
of rules and regulations, or to fraud with intent to evade tax.
    (3) Extension of time for filing distinguished. The granting of an 
extension of time for filing a return does not operate to extend the 
time for the payment of the tax or any part thereof unless so specified 
in the extension.
    (b) Certain rules relating to extensions of time for paying income 
tax to apply. The provisions of Sec. 1.6161-1 (b), (c), and (d) of this 
chapter (relating to a requirement for undue hardship, to the 
application for extension, and to payment pursuant to an extension) 
shall apply to extensions of time for payment of the tax imposed by 
chapter 54 of the Code.



Sec. 156.6165-1  Bonds where time to pay tax or deficiency has been 
extended.

    If an extension of time for payment is granted under section 6161 of 
the Code, the district director or the director of the service center 
may, if he deems it necessary, require a bond for the payment of the 
amount in respect to which the extension is granted in accordance with 
the terms of the extension. However, the bond shall not exceed double 
the amount with respect to which the extension is granted. For 
provisions relating to form of bonds, see the regulations under section 
7101 of the Code contained in part 301 of title 26 (Regulations on 
Procedure and Administration).



Sec. 156.6694-1  Section 6694 penalties applicable to tax return 
preparer.

    (a) In general. For general definitions regarding section 6694 
penalties applicable to preparers of tax returns or claims for refund 
for tax under section 5881 of the Internal Revenue Code, see Sec. 
1.6694-1 of this chapter.

[[Page 573]]

    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed, and advice provided, 
after December 31, 2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]



Sec. 156.6694-2  Penalties for understatement due to an unreasonable
position.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under section 5881 of the Internal Revenue 
Code (Code) shall be subject to penalties under section 6694(a) of the 
Code in the manner stated in Sec. 1.6694-2 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]



Sec. 156.6694-3  Penalty for understatement due to willful, reckless, 
or intentional conduct.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under section 5881 of the Internal Revenue 
Code (Code) shall be subject to penalties under section 6694(b) of the 
Code in the manner stated in Sec. 1.6694-3 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]



Sec. 156.6694-4  Extension of period of collection when tax return 
preparer pays 15 percent of a penalty for understatement of taxpayer's

liability and certain other procedural matters.

    (a) In general. For rules relating to the extension of period of 
collection when a tax return preparer who prepared a return or claim for 
refund for tax under section 5881 of the Internal Revenue Code pays 15 
percent of a penalty for understatement of taxpayer's liability and 
procedural matters relating to the investigation, assessment and 
collection of the penalties under section 6694(a) and (b), the rules 
under Sec. 1.6694-4 of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78461, Dec. 22, 2008]



Sec. 156.6695-1  Other assessable penalties with respect to the 
preparation of tax returns or claims for refund for other persons.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under section 5881 of the Internal Revenue 
Code (Code) shall be subject to penalties for failure to furnish a copy 
to the taxpayer under section 6695(a) of the Code, failure to sign the 
return under section 6695(b) of the Code, failure to furnish an 
identification number under section 6695(c) of the Code, failure to 
retain a copy or list under section 6695(d) of the Code, failure to file 
a correct information return under section 6695(e) of the Code, and 
negotiation of a check under section 6695(f) of the Code, in the manner 
stated in Sec. 1.6695-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78462, Dec. 22, 2008]



Sec. 156.6696-1  Claims for credit or refund by tax return preparers.

    (a) In general. For rules for claims for credit or refund by a tax 
return preparer who prepared a return or claim for refund for tax under 
section 5881 of the Internal Revenue Code, the rules under Sec. 1.6696-
1 of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78462, Dec. 22, 2008]



Sec. 156.7701-1  Tax return preparer.

    (a) In general. For the definition of a tax return preparer, see 
Sec. 301.7701-15 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78462, Dec. 22, 2008]

[[Page 574]]



PART 157_EXCISE TAX ON STRUCTURED SETTLEMENT FACTORING 
TRANSACTIONS--Table of Contents



      Subpart A_Tax on Structured Settlement Factoring Transactions

Sec.
157.5891-1 Imposition of excise tax on structured settlement factoring 
          transactions.

                 Subpart B_Procedure and Administration

157.6001-1 Records, statements, and special returns.
157.6011-1 General requirement of return, statement, or list.
157.6060-1 Reporting requirements for tax return preparers.
157.6061-1 Signing of returns and other documents.
157.6065-1 Verification of returns.
157.6071-1 Time for filing returns.
157.6081-1 Automatic extension of time for filing a return due under 
          chapter 55.
157.6091-1 Place for filing returns.
157.6107-1 Tax return preparer must furnish copy of return or claim for 
          refund to taxpayer and must retain a copy or record.
157.6109-1 Tax return preparers furnishing identifying numbers for 
          returns or claims for refund.
157.6151-1 Time and place for paying of tax shown on returns.
157.6161-1 Extension of time for paying tax.
157.6165-1 Bonds where time to pay tax has been extended.
157.6694-1 Section 6694 penalties applicable to tax return preparer.
157.6694-2 Penalties for understatement due to an unreasonable position.
157.6694-3 Penalty for understatement due to willful, reckless, or 
          intentional conduct.
157.6694-4 Extension of period of collection when preparer pays 15 
          percent of a penalty for understatement of taxpayer's 
          liability and certain other procedural matters.
157.6695-1 Other assessable penalties with respect to the preparation of 
          tax returns or claims for refund for other persons.
157.6696-1 Claims for credit or refund by tax return preparers.
157.7701-1 Tax return preparer.

    Authority: 26 U.S.C. 7805.
    Section 157.6001-1 also issued under 26 U.S.C. 6001;
    Section 157.6011-1 also issued under 26 U.S.C. 6011;
    Section 157.6061-1 also issued under 26 U.S.C. 6061;
    Section 157.6071-1 also issued under 26 U.S.C. 6071;
    Section 157.6081-1 also issued under 26 U.S.C. 6081(a);
    Section 157.6091-1 also issued under 26 U.S.C. 6091;
    Section 157.6060-1 also issued under 26 U.S.C. 6060(a);
    Section 157.6109-1 also issued under 26 U.S.C. 6109(a);
    Section 157.6109-2 also issued under 26 U.S.C. 6109(a);
    Section 157.6161-1 also issued under 26 U.S.C. 6161;
    Section 157.6695-1 also issued under 26 U.S.C. 6695(b).

    Source: T.D. 9134, 69 FR 41193, July 8, 2004, unless otherwise 
noted.



      Subpart A_Tax on Structured Settlement Factoring Transactions



Sec. 157.5891-1  Imposition of excise tax on structured settlement 
factoring transactions.

    (a) In general. Section 5891 imposes on any person who acquires, 
directly or indirectly, structured settlement payment rights in a 
structured settlement factoring transaction a tax equal to 40 percent of 
the factoring discount with respect to such factoring transaction.
    (b) Exceptions for certain approved transactions--(1) In general. 
The excise tax shall not apply to a structured settlement factoring 
transaction if the transfer of structured settlement payment rights is 
approved in advance in a qualified order.
    (2) Qualified order dispositive. A qualified order shall be treated 
as dispositive for purposes of this exception.
    (c) Definitions--(1) Applicable state statute means--
    (i) A statute that is enacted by the state in which the payee of the 
structured settlement is domiciled and provides for the entry of an 
order, judgment, or decree described in paragraph (c)(4)(i) of this 
section; or
    (ii) If there is no such statute, a statute that--
    (A) Is enacted by the state in which either the party to the 
structured settlement (including an assignee under a qualified 
assignment under section 130) or the person issuing the funding asset 
for the structured settlement is domiciled or has its principal place of 
business; and
    (B) Provides for the entry of such an order, judgment, or decree.
    (2) Applicable state court means, with respect to any applicable 
state statute,

[[Page 575]]

a court of the state that enacted such statute. If the payee of the 
structured settlement is not domiciled in the state that enacted the 
statute, the term also includes a court of the state in which the payee 
is domiciled.
    (3) Factoring discount means an amount equal to the excess of--
    (i) The aggregate undiscounted amount of structured settlement 
payments being acquired in the structured settlement factoring 
transaction; over
    (ii) The total amount actually paid by the acquirer to the person 
from whom such structured settlement payments are acquired.
    (4) Qualified order means a final order, judgment, or decree that--
    (i) Finds that the transfer of structured settlement payment rights 
does not contravene any Federal or state statute, or the order of any 
court or responsible administrative authority, and is in the best 
interest of the payee, taking into account the welfare and support of 
the payee's dependents; and
    (ii) Is issued under the authority of an applicable state statute by 
an applicable state court, or is issued by the responsible 
administrative authority (if any) which has exclusive jurisdiction over 
the underlying action or proceeding which was resolved by means of the 
structured settlement.
    (5) Responsible administrative authority means the administrative 
authority that had jurisdiction over the underlying action or proceeding 
that was resolved by means of the structured settlement.
    (6) State includes the Commonwealth of Puerto Rico and any 
possession of the United States.
    (7) Structured settlement means an arrangement--
    (i) That is established by--
    (A) Suit or agreement for the periodic payment of damages excludable 
from the gross income of the recipient under section 104(a)(2); or
    (B) Agreement for the periodic payment of compensation under any 
workers' compensation law excludable from the gross income of the 
recipient under section 104(a)(1); and
    (ii) Under which the periodic payments are--
    (A) Of the character described in section 130(c)(2)(A) and (B); and
    (B) Payable by a person who is a party to the suit or agreement or 
to the workers' compensation claim or by a person who has assumed the 
liability for such periodic payments under a qualified assignment in 
accordance with section 130.
    (8) Structured settlement factoring transaction means a transfer of 
structured settlement payment rights (including portions of structured 
settlement payments) made for consideration by means of sale, 
assignment, pledge, or other form of encumbrance or alienation for 
consideration other than--
    (i) The creation or perfection of a security interest in structured 
settlement payment rights under a blanket security agreement entered 
into with an insured depository institution in the absence of any action 
to redirect the structured settlement payments to such institution (or 
agent or successor thereof) or otherwise to enforce such blanket 
security interest as against the structured settlement payment rights; 
or
    (ii) A subsequent transfer of structured settlement payment rights 
acquired in a structured settlement factoring transaction.
    (9) Structured settlement payment rights means rights to receive 
payments under a structured settlement.
    (d) Coordination with other provisions of the Internal Revenue 
Code--(1) In general. If the applicable requirements of sections 72, 
104(a)(1), 104(a)(2), 130, and 461(h) were satisfied at the time the 
structured settlement involving structured settlement payment rights was 
entered into, the subsequent occurrence of a structured settlement 
factoring transaction shall not affect the application of the provisions 
of such sections to the parties to the structured settlement (including 
an assignee under a qualified assignment under section 130) in any 
taxable year.
    (2) No withholding of tax. The provisions of section 3405 regarding 
withholding of tax shall not apply to the person making the payments in 
the event of a structured settlement factoring transaction.
    (e) Effective dates. This section applies to structured settlement 
factoring transactions entered into on or

[[Page 576]]

after July 8, 2004. For structured settlement factoring transactions 
entered into before July 8, 2004, see Sec. 157.5891-1T of this chapter 
(2003-1 C.B. 564. See Sec. 601.601(d)(2) of this chapter.), as it 
appeared in the April 1, 2003, edition of 26 CFR part 157.



                 Subpart B_Procedure and Administration



Sec. 157.6001-1  Records, statements, and special returns.

    (a) In general. Any person subject to tax under chapter 55 
(Structured Settlement Factoring Transactions) of the Internal Revenue 
Code must keep such complete and detailed records as are sufficient to 
enable the Internal Revenue Service (IRS) to determine accurately the 
amount of liability under chapter 55.
    (b) Notice by the IRS requiring returns, statements, or the keeping 
of records. The IRS may require any person, by notice served upon him, 
to make such returns, render such statements, or keep such specific 
records as will enable the IRS to determine whether or not the person is 
liable for tax under chapter 55.
    (c) Retention of records. The records required by this section must 
be kept at all times available for inspection by the IRS, and shall be 
retained so long as the contents thereof may become material in the 
administration of any internal revenue law.



Sec. 157.6011-1  General requirement of return, statement, or list.

    Every person liable for tax under section 5891 must file a return 
with respect to the tax in accordance with the forms and instructions 
provided by the Internal Revenue Service.



Sec. 157.6060-1  Reporting requirements for tax return preparers.

    (a) In general. A person that employs one or more tax return 
preparers to prepare a return or claim for refund for tax under section 
5891 of the Internal Revenue Code, other than for the person, at any 
time during a return period, shall satisfy the record keeping and 
inspection requirements in the manner stated in Sec. 1.6060-1 of this 
chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78462, Dec. 22, 2008]



Sec. 157.6061-1  Signing of returns and other documents.

    Any return, statement, or other document required to be made with 
respect to a tax imposed by chapter 55 (Structured Settlement Factoring 
Transactions) of the Internal Revenue Code or the regulations under 
chapter 55 must be signed by the person required to file the return, 
statement, or other document, or by the persons required or duly 
authorized to sign in accordance with the regulations, forms, or 
instructions prescribed with respect to such return, statement, or 
document. An individual's signature on such return, statement, or other 
document shall be prima facie evidence that the individual is authorized 
to sign the return, statement, or other document.



Sec. 157.6065-1  Verification of returns.

    If a return, statement, or other document made under the provisions 
of chapter 55 (Structured Settlement Factoring Transactions) or of 
subtitle F of the Internal Revenue Code, or the regulations under those 
provisions with respect to any tax imposed by chapter 55, or the form 
and instructions issued with respect to such return, statement, or other 
document, requires that it shall contain or be verified by a written 
declaration that it is made under the penalties of perjury, it must be 
so verified by the person or persons required to sign such return, 
statement, or other document. In addition, any other statement or 
document submitted under any provision of chapter 55 or subtitle F, or 
the regulations under those provisions, with respect to any tax imposed 
by chapter 55 may be required to contain or be verified by written 
declaration that it is made under the penalties of perjury.



Sec. 157.6071-1  Time for filing returns.

    (a) In general. Except as provided in paragraph (b) of this section, 
returns required by Sec. 157.6011-1 (relating to returns of tax with 
respect to structured settlement factoring transactions)

[[Page 577]]

must be filed on or before the ninetieth day following the receipt of 
structured settlement payment rights in a structured settlement 
factoring transaction.
    (b) Returns relating to structured settlement payment rights 
received before February 19, 2003. Returns required by Sec. 157.6011-1 
that relate to structured settlement payment rights received on or 
before February 19, 2003, must be filed on or before May 20, 2003.



Sec. 157.6081-1  Automatic extension of time for filing a return due 
under chapter 55.

    (a) In general. A taxpayer required to file a return on Form 8876, 
``Excise Tax on Structured Settlement Factoring Transactions'', will be 
allowed an automatic 6-month extension of time to file the return after 
the date prescribed for filing the return if the taxpayer files an 
application under this section in accordance with paragraph (b) of this 
section.
    (b) Requirements. To satisfy this paragraph (b), the taxpayer must--
    (1) Submit a complete application on Form 7004, ``Application for 
Automatic Extension of Time to File Certain Business Income Tax, 
Information, and Other Returns,'' or in any other manner prescribed by 
the Commissioner;
    (2) File the application on or before the date prescribed for filing 
the return with the Internal Revenue Service office designated in the 
application's instructions; and
    (3) Remit the amount of the properly estimated unpaid tax liability 
on or before the date prescribed for payment.
    (c) No extension of time for the payment of tax. An automatic 
extension of time for filing a return granted under paragraph (a) of 
this section will not extend the time for payment of any tax due on such 
return.
    (d) Termination of automatic extension. The Commissioner may 
terminate an automatic extension at any time by mailing to the taxpayer 
a notice of termination at least 10 days prior to the termination date 
designated in such notice. The Commissioner must mail the notice of 
termination to the address shown on the Form 7004 or to the taxpayer's 
last known address. For further guidance regarding the definition of 
last known address, see Sec. 301.6212-2 of this chapter.
    (e) Penalties. See section 6651 for failure to file or failure to 
pay the amount shown as tax on the return.
    (f) Effective/applicability dates. This section is applicable for 
applications for an automatic extension of time to file a return due 
under chapter 55, filed after July 1, 2008.

[T.D. 9407, 73 FR 37370, July 1, 2008]



Sec. 157.6091-1  Place for filing returns.

    The return required by Sec. 157.6011-1 (relating to returns of tax 
with respect to structured settlement factoring transactions) must be 
filed at the place specified in the forms and instructions provided by 
the Internal Revenue Service.



Sec. 157.6107-1  Tax return preparer must furnish copy of return or 
claim for refund to taxpayer and must retain a copy or record.

    (a) In general. A person who is a signing tax return preparer of any 
return or claim for refund of tax under section 5891 of the Internal 
Revenue Code shall furnish a completed copy of the return or claim for 
refund to the taxpayer and retain a completed copy or record in the 
manner stated in Sec. 1.6107-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78462, Dec. 22, 2008]



Sec. 157.6109-1  Tax return preparers furnishing identifying numbers
for returns or claims for refund.

    (a) In general. Each tax return or claim for refund for tax under 
section 5891 of the Internal Revenue Code prepared by one or more 
signing tax return preparers must include the identifying number of the 
preparer required by Sec. 1.6695-1(b) of this chapter to sign the 
return or claim for refund in the manner stated in Sec. 1.6109-2 of 
this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed after December 31, 
2008.

[T.D. 9436, 73 FR 78462, Dec. 22, 2008]

[[Page 578]]



Sec. 157.6151-1  Time and place for paying of tax shown on returns.

    The tax under chapter 55 (Structured Settlement Factoring 
Transactions) of the Internal Revenue Code shown on any return must, 
without assessment or notice and demand, be paid at the time and place 
specified in the forms and instructions provided by the Internal Revenue 
Service. For provisions relating to the time and place for filing such 
return, see Sec. 157.6071-1 and Sec. 157.6091-1. For provisions 
relating to the extension of time for paying the tax, see Sec. 
157.6161-1.



Sec. 157.6161-1  Extension of time for paying tax.

    (a) In general--(1) Tax shown or required to be shown on return. The 
Internal Revenue Service may, at the request of the taxpayer, grant a 
reasonable extension of time for payment of the amount of any tax 
imposed by chapter 55 (Structured Settlement Factoring Transactions) of 
the Internal Revenue Code and shown or required to be shown on any 
return. The period of such extension shall not exceed 6 months from the 
date fixed for payment of such tax, except that in the case of a 
taxpayer that is abroad, such extension may exceed 6 months.
    (2) Extension of time for filing distinguished. The granting of an 
extension of time for filing a return does not extend the time for the 
payment of the tax or any part thereof unless so specified in the 
extension.
    (b) Certain rules relating to extension of time for paying income 
tax to apply. The provisions of Sec. 1.6161-1(b), (c), and (d) of this 
chapter (relating to a requirement for undue hardship, to the 
application for extension, and to payment pursuant to an extension) 
shall apply to extensions of time for payment of the tax imposed by 
chapter 55 of the Code.



Sec. 157.6165-1  Bonds where time to pay tax has been extended.

    If an extension of time for payment is granted under section 6161, 
the Internal Revenue Service may, if it deems necessary, require a bond 
for the payment, in accordance with the terms of the extension, of the 
amount with respect to which the extension is granted. However, the bond 
shall not exceed double the amount with respect to which the extension 
is granted. For provisions relating to the form of bonds, see the 
regulations under section 7101 contained in part 301 (Regulations on 
Procedure and Administration) of this chapter.



Sec. 157.6694-1  Section 6694 penalties applicable to tax return
preparer.

    (a) In general. For general definitions regarding section 6694 
penalties applicable to preparers of tax returns or claims for refund 
for tax under section 5891 of the Internal Revenue Code see Sec. 
1.6694-1 of this chapter.
    (b) Effective/applicability date. Paragraph (a) of this section is 
applicable to returns and claims for refund filed, and advice provided, 
after December 31, 2008.

[T.D. 9436, 73 FR 78462, Dec. 22, 2008]



Sec. 157.6694-2  Penalties for understatement due to an unreasonable
position.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under section 5891 of the Internal Revenue 
Code (Code) shall be subject to penalties under section 6694(a) of the 
Code in the manner stated in Sec. 1.6694-2 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78462, Dec. 22, 2008]



Sec. 157.6694-3  Penalty for understatement due to willful, reckless,
or intentional conduct.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under section 5891 of the Internal Revenue 
Code (Code) shall be subject to penalties under section 6694(b) of the 
Code in the manner stated in Sec. 1.6694-3 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78462, Dec. 22, 2008]

[[Page 579]]



Sec. 157.6694-4  Extension of period of collection when preparer pays
15 percent of a penalty for understatement of taxpayer's liability and

certain other procedural matters.

    (a) In general. For rules relating to the extension of period of 
collection when a tax return preparer who prepared a return or claim for 
refund for tax under section 5891 of the Internal Revenue Code pays 15 
percent of a penalty for understatement of taxpayer's liability and 
procedural matters relating to the investigation, assessment and 
collection of the penalties under section 6694(a) and (b), the rules 
under Sec. 1.6694-4 of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78462, Dec. 22, 2008]



Sec. 157.6695-1  Other assessable penalties with respect to the 
preparation of tax returns or claims for refund for other persons.

    (a) In general. A person who is a tax return preparer of any return 
or claim for refund of tax under section 5891 of the Internal Revenue 
Code (Code) shall be subject to penalties for failure to furnish a copy 
to the taxpayer under section 6695(a) of the Code, failure to sign the 
return under section 6695(b) of the Code, failure to furnish an 
identification number under section 6695(c) of the Code, failure to 
retain a copy or list under section 6695(d) of the Code, failure to file 
a correct information return under section 6695(e) of the Code, and 
negotiation of a check under section 6695(f) of the Code, in the manner 
stated in Sec. 1.6695-1 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed after December 31, 2008.

[T.D. 9436, 73 FR 78463, Dec. 22, 2008]



Sec. 157.6696-1  Claims for credit or refund by tax return preparers.

    (a) In general. For rules for claims for credit or refund by a tax 
return preparer who prepared a return or claim for refund for tax under 
section 5891 of the Internal Revenue Code, the rules under Sec. 1.6696-
1 of this chapter will apply.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78463, Dec. 22, 2008]



Sec. 157.7701-1  Tax return preparer.

    (a) In general. For the definition of a tax return preparer, see 
Sec. 301.7701-15 of this chapter.
    (b) Effective/applicability date. This section is applicable to 
returns and claims for refund filed, and advice provided, after December 
31, 2008.

[T.D. 9436, 73 FR 78463, Dec. 22, 2008]

                        PARTS 158	169 [RESERVED]



                         SUBCHAPTER E [RESERVED]



                        PARTS 170	299 [RESERVED]

[[Page 581]]



                              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 583]]



                    Table of CFR Titles and Chapters




                      (Revised as of April 1, 2012)

                      Title 1--General Provisions

         I  Administrative Committee of the Federal Register 
                (Parts 1--49)
        II  Office of the Federal Register (Parts 50--299)
       III  Administrative Conference of the United States (Parts 
                300--399)
        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 2--199)
        II  Office of Management and Budget Circulars and Guidance 
                (200--299)
            Subtitle B--Federal Agency Regulations for Grants and 
                Agreements
       III  Department of Health and Human Services (Parts 300-- 
                399)
        IV  Department of Agriculture (Parts 400--499)
        VI  Department of State (Parts 600--699)
       VII  Agency for International Development (Parts 700--799)
      VIII  Department of Veterans Affairs (Parts 800--899)
        IX  Department of Energy (Parts 900--999)
        XI  Department of Defense (Parts 1100--1199)
       XII  Department of Transportation (Parts 1200--1299)
      XIII  Department of Commerce (Parts 1300--1399)
       XIV  Department of the Interior (Parts 1400--1499)
        XV  Environmental Protection Agency (Parts 1500--1599)
     XVIII  National Aeronautics and Space Administration (Parts 
                1800--1899)
        XX  United States Nuclear Regulatory Commission (Parts 
                2000--2099)
      XXII  Corporation for National and Community Service (Parts 
                2200--2299)
     XXIII  Social Security Administration (Parts 2300--2399)
      XXIV  Housing and Urban Development (Parts 2400--2499)
       XXV  National Science Foundation (Parts 2500--2599)
      XXVI  National Archives and Records Administration (Parts 
                2600--2699)
     XXVII  Small Business Administration (Parts 2700--2799)
    XXVIII  Department of Justice (Parts 2800--2899)

[[Page 584]]

       XXX  Department of Homeland Security (Parts 3000--3099)
      XXXI  Institute of Museum and Library Services (Parts 3100--
                3199)
     XXXII  National Endowment for the Arts (Parts 3200--3299)
    XXXIII  National Endowment for the Humanities (Parts 3300--
                3399)
     XXXIV  Department of Education (Parts 3400--3499)
      XXXV  Export-Import Bank of the United States (Parts 3500--
                3599)
    XXXVII  Peace Corps (Parts 3700--3799)
     LVIII  Election Assistance Commission (Parts 5800--5899)

                        Title 3--The President

         I  Executive Office of the President (Parts 100--199)

                           Title 4--Accounts

         I  Government Accountability Office (Parts 1--199)
        II  Recovery Accountability and Transparency Board (Parts 
                200--299)

                   Title 5--Administrative Personnel

         I  Office of Personnel Management (Parts 1--1199)
        II  Merit Systems Protection Board (Parts 1200--1299)
       III  Office of Management and Budget (Parts 1300--1399)
         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 (Parts 2100--2199)
       XIV  Federal Labor Relations Authority, General Counsel of 
                the Federal Labor Relations Authority and Federal 
                Service Impasses Panel (Parts 2400--2499)
        XV  Office of Administration, Executive Office of the 
                President (Parts 2500--2599)
       XVI  Office of Government Ethics (Parts 2600--2699)
       XXI  Department of the Treasury (Parts 3100--3199)
      XXII  Federal Deposit Insurance Corporation (Parts 3200--
                3299)
     XXIII  Department of Energy (Parts 3300--3399)
      XXIV  Federal Energy Regulatory Commission (Parts 3400--
                3499)
       XXV  Department of the Interior (Parts 3500--3599)
      XXVI  Department of Defense (Parts 3600-- 3699)
    XXVIII  Department of Justice (Parts 3800--3899)
      XXIX  Federal Communications Commission (Parts 3900--3999)
       XXX  Farm Credit System Insurance Corporation (Parts 4000--
                4099)
      XXXI  Farm Credit Administration (Parts 4100--4199)

[[Page 585]]

    XXXIII  Overseas Private Investment Corporation (Parts 4300--
                4399)
     XXXIV  Securities and Exchange Commission (Parts 4400--4499)
      XXXV  Office of Personnel Management (Parts 4500--4599)
    XXXVII  Federal Election Commission (Parts 4700--4799)
        XL  Interstate Commerce Commission (Parts 5000--5099)
       XLI  Commodity Futures Trading Commission (Parts 5100--
                5199)
      XLII  Department of Labor (Parts 5200--5299)
     XLIII  National Science Foundation (Parts 5300--5399)
       XLV  Department of Health and Human Services (Parts 5500--
                5599)
      XLVI  Postal Rate Commission (Parts 5600--5699)
     XLVII  Federal Trade Commission (Parts 5700--5799)
    XLVIII  Nuclear Regulatory Commission (Parts 5800--5899)
      XLIX  Federal Labor Relations Authority (Parts 5900--5999)
         L  Department of Transportation (Parts 6000--6099)
       LII  Export-Import Bank of the United States (Parts 6200--
                6299)
      LIII  Department of Education (Parts 6300--6399)
       LIV  Environmental Protection Agency (Parts 6400--6499)
        LV  National Endowment for the Arts (Parts 6500--6599)
       LVI  National Endowment for the Humanities (Parts 6600--
                6699)
      LVII  General Services Administration (Parts 6700--6799)
     LVIII  Board of Governors of the Federal Reserve System 
                (Parts 6800--6899)
       LIX  National Aeronautics and Space Administration (Parts 
                6900--6999)
        LX  United States Postal Service (Parts 7000--7099)
       LXI  National Labor Relations Board (Parts 7100--7199)
      LXII  Equal Employment Opportunity Commission (Parts 7200--
                7299)
     LXIII  Inter-American Foundation (Parts 7300--7399)
      LXIV  Merit Systems Protection Board (Parts 7400--7499)
       LXV  Department of Housing and Urban Development (Parts 
                7500--7599)
      LXVI  National Archives and Records Administration (Parts 
                7600--7699)
     LXVII  Institute of Museum and Library Services (Parts 7700--
                7799)
    LXVIII  Commission on Civil Rights (Parts 7800--7899)
      LXIX  Tennessee Valley Authority (Parts 7900--7999)
       LXX  Court Services and Offender Supervision Agency for the 
                District of Columbia (Parts 8000--8099)
      LXXI  Consumer Product Safety Commission (Parts 8100--8199)
    LXXIII  Department of Agriculture (Parts 8300--8399)
     LXXIV  Federal Mine Safety and Health Review Commission 
                (Parts 8400--8499)
     LXXVI  Federal Retirement Thrift Investment Board (Parts 
                8600--8699)
    LXXVII  Office of Management and Budget (Parts 8700--8799)
      LXXX  Federal Housing Finance Agency (Parts 9000--9099)
    LXXXII  Special Inspector General for Iraq Reconstruction 
                (Parts 9200--9299)

[[Page 586]]

     XCVII  Department of Homeland Security Human Resources 
                Management System (Department of Homeland 
                Security--Office of Personnel Management) (Parts 
                9700--9799)

                      Title 6--Domestic Security

         I  Department of Homeland Security, Office of the 
                Secretary (Parts 1--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)
     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)

[[Page 587]]

       XXV  Office of Advocacy and Outreach, Department of 
                Agriculture (Parts 2500--2599)
      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  National Institute of Food and 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 588]]

                           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 1300--
                1399)
      XVII  Defense Nuclear Facilities Safety Board (Parts 1700--
                1799)
     XVIII  Northeast Interstate Low-Level Radioactive Waste 
                Commission (Parts 1800--1899)

                      Title 11--Federal Elections

         I  Federal Election Commission (Parts 1--9099)
        II  Election Assistance Commission (Parts 9400--9499)

                      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)
         X  Bureau of Consumer Financial Protection (Parts 1000--
                1099)
        XI  Federal Financial Institutions Examination Council 
                (Parts 1100--1199)
       XII  Federal Housing Finance Agency (Parts 1200--1299)
      XIII  Financial Stability Oversight Council (Parts 1300--
                1399)
       XIV  Farm Credit System Insurance Corporation (Parts 1400--
                1499)
        XV  Department of the Treasury (Parts 1500--1599)
       XVI  Office of Financial Research (Parts 1600--1699)
      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 (Parts 400--499)
         V  Emergency Oil and Gas Guaranteed Loan Board (Parts 
                500--599)

[[Page 589]]

                    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--1199)
         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 590]]

             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  U.S. 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  U.S. 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  Office of Workers' Compensation Programs, 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 Service, 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 591]]

                      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 (Parts 900--999)
         X  Inter-American Foundation (Parts 1000--1099)
        XI  International Boundary and Water Commission, United 
                States and Mexico, United States Section (Parts 
                1100--1199)
       XII  United States International Development Cooperation 
                Agency (Parts 1200--1299)
      XIII  Millennium Challenge Corporation (Parts 1300--1399)
       XIV  Foreign Service Labor Relations Board; Federal Labor 
                Relations Authority; General Counsel of the 
                Federal Labor Relations Authority; and the Foreign 
                Service Impasse Disputes Panel (Parts 1400--1499)
        XV  African Development Foundation (Parts 1500--1599)
       XVI  Japan-United States Friendship Commission (Parts 
                1600--1699)
      XVII  United States Institute of Peace (Parts 1700--1799)

                          Title 23--Highways

         I  Federal Highway Administration, Department of 
                Transportation (Parts 1--999)
        II  National Highway Traffic Safety Administration and 
                Federal Highway Administration, Department of 
                Transportation (Parts 1200--1299)
       III  National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 1300--1399)

                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)

[[Page 592]]

         V  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 500--599)
        VI  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 600--699) [Reserved]
       VII  Office of the Secretary, Department of Housing and 
                Urban Development (Housing Assistance Programs and 
                Public and Indian Housing Programs) (Parts 700--
                799)
      VIII  Office of the Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Section 8 Housing Assistance 
                Programs, 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)
        XV  Emergency Mortgage Insurance and Loan Programs, 
                Department of Housing and Urban Development (Parts 
                2700--2799)
        XX  Office of Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Parts 3200--3899)
      XXIV  Board of Directors of the HOPE for Homeowners Program 
                (Parts 4000--4099)
       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 (Parts 1200--1299)

[[Page 593]]

                      Title 26--Internal Revenue

         I  Internal Revenue Service, Department of the Treasury 
                (Parts 1--End)

           Title 27--Alcohol, Tobacco Products and Firearms

         I  Alcohol and Tobacco Tax and Trade Bureau, Department 
                of the Treasury (Parts 1--399)
        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)

[[Page 594]]

     XXVII  Federal Mine Safety and Health Review Commission 
                (Parts 2700--2799)
        XL  Pension Benefit Guaranty Corporation (Parts 4000--
                4999)

                      Title 30--Mineral Resources

         I  Mine Safety and Health Administration, Department of 
                Labor (Parts 1--199)
        II  Bureau of Safety and Environmental Enforcement, 
                Department of the Interior (Parts 200--299)
        IV  Geological Survey, Department of the Interior (Parts 
                400--499)
         V  Bureau of Ocean Energy Management, Department of the 
                Interior (Parts 500--599)
       VII  Office of Surface Mining Reclamation and Enforcement, 
                Department of the Interior (Parts 700--999)
       XII  Office of Natural Resources Revenue, Department of the 
                Interior (Parts 1200--1299)

                 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)
         X  Financial Crimes Enforcement Network, Department of 
                the Treasury (Parts 1000--1099)

                      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

[[Page 595]]

       XII  Defense Logistics Agency (Parts 1200--1299)
       XVI  Selective Service System (Parts 1600--1699)
      XVII  Office of the Director of National Intelligence (Parts 
                1700--1799)
     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)
    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)
       VII  Office of Educational Research and Improvement, 
                Department of Education [Reserved]
        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)

[[Page 596]]

        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)
        VI  [Reserved]
       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 (Parts 1500--
                1599)
       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 
                300--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--199)
        II  Armed Forces Retirement Home (Parts 200--299)

                       Title 39--Postal Service

         I  United States Postal Service (Parts 1--999)
       III  Postal Regulatory 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)

[[Page 597]]

          Title 41--Public Contracts and Property Management

            Subtitle A--Federal Procurement Regulations System 
                [Note]
            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)
    62-100  [Reserved]
            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)
   103-104  [Reserved]
       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)
   129-200  [Reserved]
            Subtitle D--Other Provisions Relating to Property 
                Management [Reserved]
            Subtitle E--Federal Information Resources Management 
                Regulations System [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--599)
         V  Office of Inspector General-Health Care, Department of 
                Health and Human Services (Parts 1000--1999)

[[Page 598]]

                   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 400--999)
        II  Bureau of Land Management, Department of the Interior 
                (Parts 1000--9999)
       III  Utah Reclamation Mitigation and Conservation 
                Commission (Parts 10000--10099)

             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)

                       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) 
                [Reserved]
         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)

[[Page 599]]

     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)
        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)
        IV  National Telecommunications and Information 
                Administration, Department of Commerce, and 
                National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 400--499)

           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  Health and Human Services (Parts 300--399)
         4  Department of Agriculture (Parts 400--499)
         5  General Services Administration (Parts 500--599)
         6  Department of State (Parts 600--699)
         7  Agency for International Development (Parts 700--799)
         8  Department of Veterans Affairs (Parts 800--899)
         9  Department of Energy (Parts 900--999)
        10  Department of the Treasury (Parts 1000--1099)
        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)

[[Page 600]]

        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)
        51  Department of the Army Acquisition Regulations (Parts 
                5100--5199)
        52  Department of the Navy Acquisition Regulations (Parts 
                5200--5299)
        53  Department of the Air Force Federal Acquisition 
                Regulation Supplement [Reserved]
        54  Defense Logistics Agency, Department of Defense (Parts 
                5400--5499)
        57  African Development Foundation (Parts 5700--5799)
        61  Civilian Board of Contract Appeals, General Services 
                Administration (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)

[[Page 601]]

       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 [Reserved]
       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)
        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 603]]





           Alphabetical List of Agencies Appearing in the CFR




                      (Revised as of April 1, 2012)

                                                  CFR Title, Subtitle or 
                     Agency                               Chapter

Administrative Committee of the Federal Register  1, I
Administrative Conference of the United States    1, III
Advisory Council on Historic Preservation         36, VIII
Advocacy and Outreach, Office of                  7, XXV
African Development Foundation                    22, XV
  Federal Acquisition Regulation                  48, 57
Agency for International Development              2, VII; 22, II
  Federal Acquisition Regulation                  48, 7
Agricultural Marketing Service                    7, I, IX, X, XI
Agricultural Research Service                     7, V
Agriculture Department                            2, IV; 5, LXXIII
  Advocacy and Outreach, Office of                7, XXV
  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
  Economic Research Service                       7, XXXVII
  Energy Policy and New Uses, Office of           2, IX; 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
  National Institute of Food and Agriculture      7, XXXIV
  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, L
  Rural Development Administration                7, XLII
  Rural Housing Service                           7, XVIII, XXXV, L
  Rural Telephone Bank                            7, XVI
  Rural Utilities Service                         7, XVII, XVIII, XLII, L
  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

[[Page 604]]

Appalachian Regional Commission                   5, IX
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
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
Bureau of Ocean Energy Management, Regulation,    30, II
     and Enforcement
Census Bureau                                     15, I
Centers for Medicare & Medicaid Services          42, IV
Central Intelligence Agency                       32, XIX
Chemical Safety and Hazardous Investigation       40, VI
     Board
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                       5, LXVIII; 45, VII
Civil Rights, Office for                          34, I
Court Services and Offender Supervision Agency    5, LXX
     for the District of Columbia
Coast Guard                                       33, I; 46, I; 49, IV
Coast Guard (Great Lakes Pilotage)                46, III
Commerce Department                               2, XIII; 44, IV; 50, VI
  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
  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
  National Oceanic and Atmospheric                15, IX; 50, II, III, IV, 
       Administration                             VI
  National Telecommunications and Information     15, XXIII; 47, III, IV
       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 Financial Protection Bureau              12, X
Consumer Product Safety Commission                5, LXXI; 16, II
Copyright Office                                  37, II
Copyright Royalty Board                           37, III
Corporation for National and Community Service    2, XXII; 45, XII, XXV
Cost Accounting Standards Board                   48, 99
Council on Environmental Quality                  40, V
Court Services and Offender Supervision Agency    5, LXX; 28, VIII
   for the District of Columbia
[[Page 605]]

Customs and Border Protection                     19, I
Defense Contract Audit Agency                     32, I
Defense Department                                2, XI; 5, XXVI; 32, 
                                                  Subtitle A; 40, VII
  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, 2
  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                 2, XI; 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          5, LXX; 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                          2, XXXIV; 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
Election Assistance Commission                    2, LVIII; 11, II
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                             2, IX; 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                   2, XV; 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

[[Page 606]]

  Environmental Quality, Council on               40, V
  Management and Budget, Office of                2, Subtitle A; 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
  Trade Representative, Office of the United      15, XX
       States
Export-Import Bank of the United States           2, XXXV; 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                       5, XXXVII; 11, I
Federal Emergency Management Agency               44, I
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 Agency                    5, LXXX; 12, XII
Federal Housing Finance Board                     12, IX
Federal Labor Relations Authority                 5, XIV, XLIX; 22, XIV
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
Financial Crimes Enforcement Network              31, X
Financial Research Office                         12, XVI
Financial Stability Oversight Council             12, XIII
Fine Arts, Commission on                          45, XXI
Fiscal Service                                    31, II
Fish and Wildlife Service, United States          50, I, IV
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

[[Page 607]]

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
  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          2, III; 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
  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
  Inspector General (Health Care), Office of      42, V
  Public Health Service                           42, I
  Refugee Resettlement, Office of                 45, IV
Homeland Security, Department of                  2, XXX; 6, I; 8, I
  Coast Guard                                     33, I; 46, I; 49, IV
  Coast Guard (Great Lakes Pilotage)              46, III
  Customs and Border Protection                   19, I
  Federal Emergency Management Agency             44, I
  Human Resources Management and Labor Relations  5, XCVII
       Systems
  Immigration and Customs Enforcement Bureau      19, IV
  Transportation Security Administration          49, XII
HOPE for Homeowners Program, Board of Directors   24, XXIV
     of
Housing and Urban Development, Department of      2, XXIV; 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

[[Page 608]]

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
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
Inspector General
  Agriculture Department                          7, XXVI
  Health and Human Services Department            42, V
  Housing and Urban Development Department        24, XII, XV
Institute of Peace, United States                 22, XVII
Inter-American Foundation                         5, LXIII; 22, X
Interior Department                               2, XIV
  American Indians, Office of the Special         25, VII
       Trustee
  Bureau of Ocean Energy Management, Regulation,  30, II
       and Enforcement
  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
  National Indian Gaming Commission               25, III
  National Park Service                           36, I
  Natural Resource Revenue, Office of             30, XII
  Ocean Energy Management, Bureau of              30, V
  Reclamation, Bureau of                          43, I
  Secretary of the Interior, Office of            2, XIV; 43, Subtitle A
  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 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
Investment Security, Office of                    31, VIII
Iraq Reconstruction, Special Inspector General    5, LXXXVII
     for
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                                2, XXVIII; 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

[[Page 609]]

  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
  Office of Workers' Compensation Programs        20, VII
  Public Contracts                                41, 50
  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, LXIV
Micronesian Status Negotiations, Office for       32, XXVII
Millennium Challenge Corporation                  22, XIII
Mine Safety and Health Administration             30, I
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
Museum and Library Services, Institute of         2, XXXI
National Aeronautics and Space Administration     2, XVIII; 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   2, XXII; 45, XII, XXV
National Archives and Records Administration      2, XXVI; 5, LXVI; 36, XII
  Information Security Oversight Office           32, XX
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 Endowment for the Arts                   2, XXXII
National Endowment for the Humanities             2, XXXIII
National Foundation on the Arts and the           45, XI
     Humanities
National Highway Traffic Safety Administration    23, II, III; 47, VI; 49, V
National Imagery and Mapping Agency               32, I
National Indian Gaming Commission                 25, III
National Institute for Literacy                   34, XI
National Institute of Food and Agriculture        7, XXXIV
National Institute of Standards and Technology    15, II
National Intelligence, Office of Director of      32, XVII
National Labor Relations Board                    5, LXI; 29, I
National Marine Fisheries Service                 50, II, IV
National Mediation Board                          29, X

[[Page 610]]

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                       2, XXV; 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, IV
     Administration
National Transportation Safety Board              49, VIII
Natural Resources Conservation Service            7, VI
Natural Resource Revenue, Office of               30, XII
Navajo and Hopi Indian Relocation, Office of      25, IV
Navy Department                                   32, VI
  Federal Acquisition Regulation                  48, 52
Neighborhood Reinvestment Corporation             24, XXV
Northeast Interstate Low-Level Radioactive Waste  10, XVIII
     Commission
Nuclear Regulatory Commission                     2, XX; 5, XLVIII; 10, I
  Federal Acquisition Regulation                  48, 20
Occupational Safety and Health Administration     29, XVII
Occupational Safety and Health Review Commission  29, XX
Ocean Energy Management, Bureau of                30, V
Offices of Independent Counsel                    28, VI
Office of Workers' Compensation Programs          20, VII
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                                       2, XXXVII; 22, III
Pennsylvania Avenue Development Corporation       36, IX
Pension Benefit Guaranty Corporation              29, XL
Personnel Management, Office of                   5, I, XXXV; 45, VIII
  Human Resources Management and Labor Relations  5, XCVII
       Systems, Department of Homeland Security
  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 Regulatory 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
Recovery Accountability and Transparency Board    4, II
Refugee Resettlement, Office of                   45, IV
Relocation Allowances                             41, 302
Research and Innovative Technology                49, XI
     Administration
Rural Business-Cooperative Service                7, XVIII, XLII, L
Rural Development Administration                  7, XLII
Rural Housing Service                             7, XVIII, XXXV, L

[[Page 611]]

Rural Telephone Bank                              7, XVI
Rural Utilities Service                           7, XVII, XVIII, XLII, L
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                5, XXXIV; 17, II
Selective Service System                          32, XVI
Small Business Administration                     2, XXVII; 13, I
Smithsonian Institution                           36, V
Social Security Administration                    2, XXIII; 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                                  2, VI; 22, I; 28, XI
  Federal Acquisition Regulation                  48, 6
Surface Mining Reclamation and Enforcement,       30, VII
     Office of
Surface Transportation Board                      49, X
Susquehanna River Basin Commission                18, VIII
Technology Administration                         15, XI
Technology Policy, Assistant Secretary for        37, IV
Technology, Under Secretary for                   37, V
Tennessee Valley Authority                        5, LXIX; 18, XIII
Thrift Supervision Office, Department of the      12, V
     Treasury
Trade Representative, United States, Office of    15, XX
Transportation, Department of                     2, XII; 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; 47, IV; 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                   19, I
  Engraving and Printing, Bureau of               31, VI
  Federal Acquisition Regulation                  48, 10
  Federal Claims Collection Standards             31, IX
  Federal Law Enforcement Training Center         31, VII
  Financial Crimes Enforcement Network            31, X
  Fiscal Service                                  31, II
  Foreign Assets Control, Office of               31, V
  Internal Revenue Service                        26, I
  Investment Security, 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

[[Page 612]]

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                       2, VIII; 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 613]]







                      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
1.44B-1....................................................    1545-0219
1.45D-1....................................................    1545-1765
1.45G-1....................................................    1545-2031
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.....................................................    1545-0155
                                                               1545-0166
1.47-3.....................................................    1545-0155
                                                               1545-0166
1.47-4.....................................................    1545-0123
1.47-5.....................................................    1545-0092
1.47-6.....................................................    1545-0099
1.48-3.....................................................    1545-0155
1.48-4.....................................................    1545-0155
                                                               1545-0808
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
1.52-3.....................................................    1545-0219

[[Page 614]]

 
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
1.108-7....................................................    1545-2155
1.108(i)-1T................................................    1545-2147
1.108(i)-2T................................................    1545-2147
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
1.162-24...................................................    1545-2115
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

[[Page 615]]

 
1.167(a)-7.................................................    1545-0172
1.167(a)-11................................................    1545-0152
                                                               1545-0172
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..................................................    1545-0074
                                                               1545-0123
                                                               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
1.179B-1T..................................................    1545-2076
1.179C-1...................................................    1545-2103
1.179C-1T..................................................    1545-2103
1.180-2....................................................    1545-0074
1.181-1....................................................    1545-2059
1.181-2....................................................    1545-2059
1.181-3....................................................    1545-2059
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
1.199-6....................................................    1545-1966
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
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....................................................    1545-2019
1.337(d)-1.................................................    1545-1160
1.337(d)-2.................................................    1545-1160
                                                               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
1.338-11...................................................    1545-1990
1.338(h)(10)-1.............................................    1545-1658
1.338(i)-1.................................................    1545-1990
1.341-7....................................................    1545-0123
1.351-3....................................................    1545-2019
1.355-5....................................................    1545-2019
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

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                                                               1545-2056
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....................................................    1545-2019
1.371-1....................................................    1545-0123
1.371-2....................................................    1545-0123
1.374-3....................................................    1545-0123
1.381(b)-1.................................................    1545-0123
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)(22)-1.............................................    1545-1990
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....................................................    1545-1120
                                                               1545-1260
                                                               1545-1275
                                                               1545-1324
1.382-11...................................................    1545-2019
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
1.402A-1...................................................    1545-1992
1.403(b)-1.................................................    1545-0710
1.403(b)-3.................................................    1545-0996
1.403(b)-7.................................................    1545-1341
1.403(b)-10................................................    1545-2068
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
1.430(f)-1.................................................    1545-2095
1.430(g)-1.................................................    1545-2095
1.430(h)(2)-1..............................................    1545-2095
1.436-1....................................................    1545-2095
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
1.448-2....................................................    1545-1855
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

[[Page 617]]

 
                                                               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
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-3(h), 1.468A-7, and 1.468A-8(d).....................    1545-2091
1.468A-4...................................................    1545-0954
1.468A-7...................................................    1545-0954
                                                               1545-1511
1.468A-8...................................................    1545-1269
1.468B-1...................................................    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
1.468B-9...................................................    1545-1631
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(a)-4.................................................    1545-1945
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
1.482-9(b).................................................    1545-2149
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

[[Page 618]]

 
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
1.664-1....................................................    1545-0196
1.664-1(a)(7)..............................................    1545-1536
1.664-1(c).................................................    1545-2101
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....................................................    1545-0074
                                                               1545-0099
                                                               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
1.752-2....................................................    1545-1905
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
1.822-5....................................................    1545-1027
1.822-6....................................................    1545-1027
1.822-8....................................................    1545-1027
1.822-9....................................................    1545-1027
1.823-2....................................................    1545-1027
1.823-5....................................................    1545-1027
1.823-6....................................................    1545-1027
1.825-1....................................................    1545-1027
1.826-1....................................................    1545-1027
1.826-2....................................................    1545-1027
1.826-3....................................................    1545-1027
1.826-4....................................................    1545-1027
1.826-6....................................................    1545-1027
1.831-3....................................................    1545-0123
1.831-4....................................................    1545-0123
1.832-4....................................................    1545-1227
1.832-5....................................................    1545-0123
1.848-2(g)(8)..............................................    1545-1287
1.848-2(h)(3)..............................................    1545-1287
1.848-2(i)(4)..............................................    1545-1287
1.851-2....................................................    1545-1010
1.851-4....................................................    1545-0123
1.852-1....................................................    1545-0123
1.852-4....................................................    1545-0123
                                                               1545-0145
1.852-6....................................................    1545-0123
                                                               1545-0144
1.852-7....................................................    1545-0074
1.852-9....................................................    1545-0074
                                                               1545-0123
                                                               1545-0144
                                                               1545-0145
                                                               1545-1783
1.852-11...................................................    1545-1094
1.853-3....................................................    1545-2035
1.853-4....................................................    1545-2035
1.854-2....................................................    1545-0123
1.855-1....................................................    1545-0123
1.856-2....................................................    1545-0123
                                                               1545-1004
1.856-6....................................................    1545-0123
1.856-7....................................................    1545-0123
1.856-8....................................................    1545-0123
1.857-8....................................................    1545-0123
1.857-9....................................................    1545-0074
1.858-1....................................................    1545-0123
1.860-2....................................................    1545-0045
1.860-4....................................................    1545-0045
                                                               1545-1054
                                                               1545-1057
1.860E-1...................................................    1545-1675
1.860E-2(a)(5).............................................    1545-1276
1.860E-2(a)(7).............................................    1545-1276
1.860E-2(b)(2).............................................    1545-1276
1.860G-2...................................................    1545-2110
1.861-2....................................................    1545-0089
1.861-3....................................................    1545-0089
1.861-4....................................................    1545-1900
1.861-8....................................................    1545-0126
1.861-8(e)(6) and (g)......................................    1545-1224
1.861-9T...................................................    1545-0121
                                                               1545-1072
1.861-18...................................................    1545-1594
1.863-1....................................................    1545-1476

[[Page 619]]

 
1.863-3....................................................    1545-1476
                                                               1545-1556
1.863-3A...................................................    1545-0126
1.863-4....................................................    1545-0126
1.863-7....................................................    1545-0132
1.863-8....................................................    1545-1718
1.863-9....................................................    1545-1718
1.864-4....................................................    1545-0126
1.871-1....................................................    1545-0096
1.871-6....................................................    1545-0795
1.871-7....................................................    1545-0089
1.871-10...................................................    1545-0089
                                                               1545-0165
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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
1.6045-1(c)(3)(xi)(C)......................................    1545-2186
1.6045A-1..................................................    1545-2186
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

[[Page 623]]

 
                                                               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-1T.................................................    1545-0901
1.6050H-2..................................................    1545-0901
                                                               1545-1339
                                                               1545-1380
1.6050I-2..................................................    1545-1449
1.6050J-1T.................................................    1545-0877
1.6050K-1..................................................    1545-0941
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
1.6060-1(a)(1).............................................    1545-1231
1.6061-1...................................................    1545-0123
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
                                                               1545-1036
                                                               1545-1054
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
                                                               1545-1231
1.6109-1...................................................    1545-0074
1.6109-2...................................................    1545-2176
1.6115-1...................................................    1545-1464
1.6151-1...................................................    1545-0074
1.6153-1...................................................    1545-0087
1.6153-4...................................................    1545-0087
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(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
1.6694-2(c)(3).............................................    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

[[Page 624]]

 
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...................................................    1545-0042
                                                               1545-0074
                                                               1545-0098
                                                               1545-0129
                                                               1545-0172
                                                               1545-0582
                                                               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
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
20.6060-1(a)(1)............................................    1545-1231
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
20.6107-1..................................................    1545-1231
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

[[Page 625]]

 
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
25.6060-1(a)(1)............................................    1545-1231
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
25.6107-1..................................................    1545-1231
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
26.2642-6..................................................    1545-1902
26.2652-2..................................................    1545-0985
26.2654-1..................................................    1545-1902
26.2662-1..................................................    1545-0015
                                                               1545-0985
26.2662-2..................................................    1545-0985
26.6060-1(a)(1)............................................    1545-1231
26.6107-1..................................................    1545-1231
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
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
                                                               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
                                                               1545-0256

[[Page 626]]

 
                                                               1545-0718
                                                               1545-2097
31.6011(a)-2...............................................    1545-0001
                                                               1545-0002
31.6011(a)-3...............................................    1545-0028
31.6011(a)-3A..............................................    1545-0955
31.6011(a)-4...............................................    1545-0034
                                                               1545-0035
                                                               1545-0718
                                                               1545-1413
                                                               1545-2097
31.6011(a)-5...............................................    1545-0028
                                                               1545-0718
                                                               1545-2097
31.6011(a)-6...............................................    1545-0028
31.6011(a)-7...............................................    1545-0074
31.6011(a)-8...............................................    1545-0028
31.6011(a)-9...............................................    1545-0028
31.6011(a)-10..............................................    1545-0112
31.6011(b)-1...............................................    1545-0003
31.6011(b)-2...............................................    1545-0029
31.6051-1..................................................    1545-0008
                                                               1545-0182
                                                               1545-0458
                                                               1545-1729
31.6051-2..................................................    1545-0008
31.6051-3..................................................    1545-0008
31.6053-1..................................................    1545-0029
                                                               1545-0062
                                                               1545-0064
                                                               1545-0065
                                                               1545-1603
31.6053-2..................................................    1545-0008
31.6053-3..................................................    1545-0065
                                                               1545-0714
31.6053-4..................................................    1545-0065
                                                               1545-1603
31.6060-1(a)(1)............................................    1545-1231
31.6065(a)-1...............................................    1545-0029
31.6071(a)-1...............................................    1545-0001
                                                               1545-0028
                                                               1545-0029
31.6071(a)-1A..............................................    1545-0955
31.6081(a)-1...............................................    1545-0008
                                                               1545-0028
31.6091-1..................................................    1545-0028
                                                               1545-0029
31.6107-1..................................................    1545-1231
31.6157-1..................................................    1545-0955
31.6205-1..................................................    1545-0029
                                                               1545-2097
31.6301(c)-1AT.............................................    1545-0035
                                                               1545-0112
                                                               1545-0257
31.6302-1..................................................    1545-1413
31.6302-2..................................................    1545-1413
31.6302-3..................................................    1545-1413
31.6302-4..................................................    1545-1413
31.6302(c)-2...............................................    1545-0001
                                                               1545-0257
31.6302(c)-2A..............................................    1545-0955
31.6302(c)-3...............................................    1545-0257
31.6402(a)-2...............................................    1545-0256
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31.6413(a)-1...............................................    1545-0029
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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
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32.1.......................................................    1545-0029
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32.2.......................................................    1545-0029
35a.3406-2.................................................    1545-0112
35a.9999-5.................................................    1545-0029
36.3121(l)(1)-1............................................    1545-0137
36.3121(l)(1)-2............................................    1545-0137
36.3121(l)(3)-1............................................    1545-0123
36.3121(1)(7)-1............................................    1545-0123
36.3121(1)(10)-1...........................................    1545-0029
36.3121(1)(10)-3...........................................    1545-0029
36.3121(1)(10)-4...........................................    1545-0257
40.6060-1(a)(1)............................................    1545-1231
40.6107-1..................................................    1545-1231
40.6302(c)-3(b)(2)(ii).....................................    1545-1296
40.6302(c)-3(b)(2)(iii)....................................    1545-1296
40.6302(c)-3(e)............................................    1545-1296
40.6302(c)-3(f)(2)(ii).....................................    1545-1296
41.4481-1..................................................    1545-0143
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41.6060-1(a)(1)............................................    1545-1231
41.6071(a)-1...............................................    1545-0143
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41.6151(a)-1...............................................    1545-0143
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41.6161(a)(1)-1............................................    1545-0143
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48.4081-4(b)(2)(ii)........................................    1545-1270
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48.4081-4(c)...............................................    1545-1270
48.4081-6(c)(1)(ii)........................................    1545-1270
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48.4161(a)-1...............................................    1545-0723
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48.4161(a)-3...............................................    1545-0723
48.4161(b)-1...............................................    1545-0723
48.4216(a)-2...............................................    1545-0023
48.4216(a)-3...............................................    1545-0023
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48.4222(a)-1...............................................    1545-0014
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48.6302(c)-1...............................................    1545-0023
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48.6416(a)-2...............................................    1545-0723
48.6416(a)-3...............................................    1545-0723
48.6416(b)(1)-1............................................    1545-0723
48.6416(b)(1)-2............................................    1545-0723
48.6416(b)(1)-3............................................    1545-0723
48.6416(b)(1)-4............................................    1545-0723
48.6416(b)(2)-1............................................    1545-0723
48.6416(b)(2)-2............................................    1545-0723
48.6416(b)(2)-3............................................    1545-0723
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48.6416(b)(2)-4............................................    1545-0723
48.6416(b)(3)-1............................................    1545-0723
48.6416(b)(3)-2............................................    1545-0723
48.6416(b)(3)-3............................................    1545-0723
48.6416(b)(4)-1............................................    1545-0723
48.6416(b)(5)-1............................................    1545-0723
48.6416(c)-1...............................................    1545-0723
48.6416(e)-1...............................................    1545-0023
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48.6416(f)-1...............................................    1545-0023
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48.6416(g)-1...............................................    1545-0723
48.6416(h)-1...............................................    1545-0723
48.6420(c)-2...............................................    1545-0023
48.6420(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
49.4253-4..................................................    1545-0023
49.4264(b)-1...............................................    1545-0023
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49.4271-1(d)...............................................    1545-0685
51.8T......................................................    1545-2209
52.4682-1(b)(2)(iii).......................................    1545-1153
52.4682-2(b)...............................................    1545-1153
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52.4682-2(d)...............................................    1545-1153
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52.4682-3(c)(2)............................................    1545-1153
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52.4682-5(d)...............................................    1545-1361
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53.4940-1..................................................    1545-0052
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53.4942(a)-1...............................................    1545-0052
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53.4942(b)-3...............................................    1545-0052
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53.6107-1..................................................    1545-1231
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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
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54.6060-1(a)(1)............................................    1545-1231
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54.9801-3..................................................    1545-1537
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54.9801-6..................................................    1545-1537
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54.9815-2711T..............................................    1545-2179
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54.9815-2719AT.............................................    1545-2181
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55.6001-1..................................................    1545-0123
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55.6060-1(a)(1)............................................    1545-1231
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56.4911-6..................................................    1545-0052
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56.6161-1..................................................    1545-0257
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301.6011(g)-1..............................................    1545-2079
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301.6035-1.................................................    1545-0123
301.6036-1.................................................    1545-0013
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301.6047-1.................................................    1545-0367
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301.6058-1.................................................    1545-0710
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
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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
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301.6114-1.................................................    1545-1126
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301.6223(h)-1..............................................    1545-0790
301.6224(b)-1..............................................    1545-0790
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
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301.6231(c)-2..............................................    1545-0790
301.6241-1T................................................    1545-0130
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301.6316-7.................................................    1545-0029
301.6324A-1................................................    1545-0015
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301.6405-1.................................................    1545-0024
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301.6501(d)-1..............................................    1545-0074
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301.6501(o)-2..............................................    1545-0728
301.6511(d)-1..............................................    1545-0024
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301.6511(d)-2..............................................    1545-0024
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301.6511(d)-3..............................................    1545-0024
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301.6723-1A(d).............................................    1545-0909
301.6903-1.................................................    1545-0013
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301.7001-1.................................................    1545-0123
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301.7517-1.................................................    1545-0015
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301.7623-1.................................................    1545-0409
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301.7701-7.................................................    1545-1600
301.7701-16................................................    1545-0795
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301.7701(b)-2..............................................    1545-0089
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301.7701(b)-5..............................................    1545-0089
301.7701(b)-6..............................................    1545-0089
301.7701(b)-7..............................................    1545-0089
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301.7701(b)-9..............................................    1545-0089
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301.9000-5.................................................    1545-1850
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301.9100-2.................................................    1545-1488
301.9100-3.................................................    1545-1488
301.9100-4T................................................    1545-0016
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301.9100-6T................................................    1545-0872
301.9100-7T................................................    1545-0982
301.9100-8.................................................    1545-1112
301.9100-11T...............................................    1545-0123
301.9100-12T...............................................    1545-0026
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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

[[Page 630]]

Finding Aids section of the printed volume and at www.fdsys.gov.

    Effective Date Note: At 77 FR 8700, February 14, 2012, Sec.  602.101 
was amended by adding the following entry in numerical order to the 
table, effective April 16, 2012. For the convenience of the user, the 
added text is set forth as follows:

Sec.  602.101  OMB Control numbers.

                                * * * * *

    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
   CFR part or section where identified and described       control No.
------------------------------------------------------------------------
 
                                * * * * *
54.9815-2715............................................       1545-2229
 
                                * * * * *
------------------------------------------------------------------------


[[Page 631]]



List of CFR Sections Affected



All changes in this volume 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
53.4958-0T Added....................................................2156
53.4958-1T Added....................................................2156
53.4958-2T Added....................................................2156
53.4958-3T Added....................................................2156
53.4958-4T Added....................................................2156
    (a)(3)(vii) Examples 1, 6 and (c)(3)(i)(B) corrected...........13013
53.4958-6T Added....................................................2156
    (a)(1) and (c)(2)(iv) Examples 2 and 4 corrected...............13013
53.4958-7T Added....................................................2156
53.4958-8T Added....................................................2156
53.4963-1 (a), (b) and (c) amended..................................2171
54 Authority citation amended.......................................1848
54.4980B-0 Amended..................................................1848
54.4980B-1 Amended..................................................1849
54.4980B-2 Amended..................................................1849
54.4980B-3 Amended..................................................1852
54.4980B-4 Amended..................................................1852
54.4980B-5 Amended..................................................1852
54.4980B-6 Amended..................................................1853
54.4980B-7 Amended..................................................1853
54.4980B-8 Amended..................................................1854
54.4980B-9 Added....................................................1855
54.4980B-10 Added...................................................1855
54.9802-1 Added; interim............................................1396
    (i)(1) amended; interim........................................14077
54.9802-1T Removed; interim.........................................1396
    Added; interim..................................................1397
    (i)(1), (3)(ii)(A) introductory text and (C) Example 2 (ii) 
amended; interim...................................................14077

                                  2002

26 CFR
                                                                   67 FR
                                                                    Page
Chapter I
53.4958-0 Added.....................................................3083
53.4958-0T Removed..................................................3083
53.4958-1 Added.....................................................3083
53.4958-1T Removed..................................................3083
53.4958-2 Added.....................................................3083
53.4958-2T Removed..................................................3083
53.4958-3 Added.....................................................3083
53.4958-3T Removed..................................................3083
53.4958-4 Added.....................................................3083
    (a)(3)(vii) Example 1 and (c)(4) Example 2 corrected...........12472
53.4958-4T Removed..................................................3083
53.4958-5 Added.....................................................3083
53.4958-5T Removed..................................................3083
53.4958-6 Added.....................................................3083
53.4958-6T Removed..................................................3083
53.4958-7 Added.....................................................3083
53.4958-7T Removed..................................................3083
53.4958-8 Added.....................................................3083
53.4958-8T Removed..................................................3083
53.6011-4T Added...................................................64806
54 Authority citation amended......................................19026
54.4974-2 Added....................................................19026
    Corrected......................................................35732
54.6011-4T Added...................................................64806
56.6011-4T Added...................................................64806

                                  2003

26 CFR
                                                                   68 FR
                                                                    Page
Chapter I
53.6011-4 Added....................................................10169
53.6011-4T Removed.................................................10170

[[Page 632]]

54 Authority citation amended......................................17281
54.4980F-1 Added...................................................17281
54.6011-4 Added....................................................10170
54.6011-4T Removed.................................................10170
56.6011-4 Added....................................................10170
56.6011-4T Removed.................................................10170
157 Added...........................................................7923

                                  2004

26 CFR
                                                                   69 FR
                                                                    Page
Chapter I
53.6081-1 (a) and (b) amended......................................70550
53.6091-1 (a) through (d) amended..................................55746
53.6091-2 Amended..................................................55746
54 Authority citation amended......................................78746
54.4974-2 Amended..................................................33293
54.4979-1 (b)(1), (2), (c)(1), (2) and (3) amended.................78153
54.9801-1 Added....................................................78746
54.9801-1T Removed.................................................78746
54.9801-2 Added....................................................78746
54.9801-2T Removed.................................................78746
54.9801-3 Added....................................................78746
54.9801-3T Removed.................................................78746
54.9801-4 Added....................................................78746
54.9801-4T Removed.................................................78746
54.9801-5 Added....................................................78746
54.9801-5T Removed.................................................78746
54.9801-6 Added....................................................78746
54.9801-6T Removed.................................................78746
54.9831-1 Added....................................................78746
54.9831-1T Removed.................................................78746
54.9833-1 Added....................................................78746
54.9833-1T Removed.................................................78746
55 Authority citation amended......................................70550
55.6081-1 Amended..................................................70550
55.6091-1 (a) and (b) amended......................................55746
55.6091-2 Amended..................................................55746
156 Authority citation revised.....................................70550
156.6081-1 (a) and (b) amended.....................................70550
156.6091-1 (a), (b), (c) and (e) amended; (d) revised..............55746
156.6091-2 Amended.................................................55747
157 Revised........................................................41193

                                  2005

26 CFR
                                                                   70 FR
                                                                    Page
Chapter I
53 Authority citation amended......................................67362
53.6081-1 Removed..................................................67362
53.6081-1T Added...................................................67362
54 Policy statement.........................................55500, 59620
54.4980F-1 Amended.................................................47126
54.9831-1 (c)(3)(iii)(B) correctly amended.........................21146
55 Authority citation amended......................................67362
55.6081-1 Removed..................................................67362
55.6081-1T Added...................................................67362
156 Authority citation amended.....................................67363
156.6081-1 Removed.................................................67363
156.6081-1T Added..................................................67363
157 Authority citation amended.....................................67363
157.6081-1 Removed.................................................67363
157.6081-1T Added..................................................67363

                                  2006

26 CFR
                                                                   71 FR
                                                                    Page
Chapter I
54 Authority citation amended........................43058, 75030, 75056
54.4980F-1 Amended.................................................61888
54.4980G-0 Added...................................................43058
    Correctly amended..............................................53967
54.4980G-1 Added...................................................43058
54.4980G-2 Added...................................................43058
54.4980G-3 Added...................................................43058
54.4980G-4 Added...................................................43058
    Correctly amended..............................................53967
54.4980G-5 Added...................................................43058
54.9801-1 (a) revised..............................................75056
54.9801-2 Introductory text revised................................75056
54.9802-1 Revised..................................................75030
54.9802-1T Removed.................................................75030
54.9802-2 Added....................................................75056
54.9831-1 (b) and (c)(1) revised...................................75057

                                  2007

26 CFR
                                                                   72 FR
                                                                    Page
Chapter I
53 Technical correction............................................50211
53.6011-1 (b) amended..............................................36872
53.6011-4 Revised..................................................43154
53.6071-1 (g) and (h) added........................................36872
53.6071-1T Added...................................................36872

[[Page 633]]

    (h)(2) correctly revised.......................................45895
54 Technical correction............................................50211
54.4974-2 Amended..................................................41160
54.6011-1 (c) and (d) added........................................36873
54.6011-1T Existing text designated as (a); new (a) heading, (c) 
        and (d) added..............................................36873
    (d)(2) correctly revised.......................................45895
54.6011-4 Revised..................................................43154
54.9802-1 (b)(2)(i)(D) Example 4 and (f)(1) correctly amended.......7929
56.6011-4 Revised..................................................43154

                                  2008

26 CFR
                                                                   73 FR
                                                                    Page
Chapter I
53 Authority citation amended...............................37369, 78457
53.4958-2 (a)(6) added.............................................16521
53.6060-1 Added....................................................78457
53.6081-1 Added....................................................37369
53.6081-1T Removed.................................................37369
53.6107-1 Added....................................................78457
53.6109-1 Added....................................................78457
53.6694-1 Added....................................................78457
53.6694-2 Added....................................................78457
53.6694-3 Added....................................................78457
53.6694-4 Added....................................................78458
53.6695-1 Added....................................................78458
53.6696-1 Added....................................................78458
53.7701-1 Added....................................................78458
54 Authority citation amended...............................62419, 78458
54.4980G-0 Amended.................................................20795
54.4980G-4 Amended.................................................20795
54.6060-1 Added....................................................78458
54.6107-1 Added....................................................78458
54.6109-1 Added....................................................78458
54.6694-1 Added....................................................78458
54.6694-2 Added....................................................78458
54.6694-3 Added....................................................78458
54.6694-4 Added....................................................78459
54.6695-1 Added....................................................78459
54.6696-1 Added....................................................78459
54.7701-1 Added....................................................78459
54.9801-1 (a) amended..............................................62419
54.9801-2 Introductory text amended................................62420
54.9811-1 Added....................................................62420
54.9811-1T Removed.................................................62422
54.9831-1 (b) amended..............................................62422
55 Authority citation amended...............................37369, 78459
55.6060-1 Added....................................................78459
55.6081-1 Added....................................................37369
55.6081-1T Removed.................................................37370
55.6107-1 Added....................................................78459
55.6109-1 Added....................................................78459
55.6694-1 Added....................................................78459
55.6694-2 Added....................................................78459
55.6694-3 Added....................................................78459
55.6694-4 Added....................................................78460
55.6695-1 Added....................................................78460
55.6696-1 Added....................................................78460
55.7701-1 Added....................................................78460
56 Authority citation amended......................................78460
56.6060-1 Added....................................................78460
56.6107-1 Added....................................................78460
56.6109-1 Added....................................................78460
56.6694-1 Added....................................................78460
56.6694-2 Added....................................................78460
56.6694-3 Added....................................................78460
56.6694-4 Added....................................................78461
56.6695-1 Added....................................................78461
56.6696-1 Added....................................................78461
56.7701-1 Added....................................................78461
156 Authority citation amended..............................37370, 78461
156.6060-1 Added...................................................78461
156.6081-1 Added...................................................37370
156.6081-1T Removed................................................37370
156.6107-1 Added...................................................78461
156.6109-1 Added...................................................78461
156.6694-1 Added...................................................78461
156.6694-2 Added...................................................78461
156.6694-3 Added...................................................78461
156.6694-4 Added...................................................78461
156.6695-1 Added...................................................78462
156.6696-1 Added...................................................78462
156.7701-1 Added...................................................78462
157 Authority citation amended..............................37370, 78462
157.6060-1 Added...................................................78462
157.6081-1 Added...................................................37370
157.6081-1T Removed................................................37370
157.6107-1 Added...................................................78462
157.6109-1 Added...................................................78462
157.6694-1 Added...................................................78462
157.6694-2 Added...................................................78462
157.6694-3 Added...................................................78462
157.6694-4 Added...................................................78462
157.6695-1 Added...................................................78463
157.6696-1 Added...................................................78463
157.7701-1 Added...................................................78463

[[Page 634]]

                                  2009

26 CFR
                                                                   74 FR
                                                                    Page
Chapter I
53 Authority citation amended.......................................5106
54 Authority citation amended.........................5106, 45997, 51678
    Technical correction.............................11644, 51237, 68149
54.4979-1 (c)(1) revised............................................8214
54.4980B-0 Amended.................................................45997
54.4980B-2 Amended.................................................45997
54.4980D-1 Added...................................................45997
54.4980E-1 Added...................................................45997
54.4980F-1 Amended.................................................61276
54.4980G-1 Amended.................................................45997
54.4980G-3 Heading revised; text amended...........................45998
54.4980G-4 Amended.................................................45998
54.4980G-6 Added...................................................45998
54.4980G-7 Added...................................................45999
54.6011-2 Added....................................................45999
54.6061-1 Added...................